What is a reverse mortgage & what problems may arise with one?

by Alan Knowsley - Rainey Collins Lawyers

Reverse mortgages, also called Home Equity Release mortgages, have been heavily promoted, particularly to the elderly who own their own homes. Reverse mortgages are loans secured against your home by a mortgage, where the loan amount, together with all the interest on that loan, does not become payable until you leave your home, e.g. if you sell, go into a rest home, or on your death. For people living on a modest retirement income these loans can enable unexpected one-off expenses to be met, such as having to replace a roof or other major repairs, or having major surgery.

Home equity loans are much more expensive then ordinary mortgages. Some companies currently offering these loans all charge up front fees, and in addition you will incur a house valuation fee and legal fees so you need to be prepared for this. The interest rate of these loans are significantly higher than an ordinary mortgage. The total interest payable over the term of the loan is also very much more because it compounds, and the loan amount does not reduce during the term of the loan, unlike most mortgages. A $15,000 loan at 11% compounding annually grows to $38,370 over ten years, and $64,656 over fifteen.

The overall effect is that your equity in your home can be quickly eroded by the operation of one of these loans. This might make it difficult in the future to move from your home to a smaller property, or to buy a unit in a retirement village. In some cases you would be able to take the loan with you if you want to move to another property. Obviously the amount left for your family out of your estate can be seriously eroded, because of all the interest mounting up.

What should you do?

Because these mortgages are so expensive, we suggest that the first thing to do is always to explore other options first. If your income is sufficient, try getting a small ordinary mortgage. This will cost much less overall. Consider moving to a smaller home now, and releasing some of your cash equity that way. Also see if your family can lend you the money instead. It will be much cheaper and will preserve the family home as an asset.

If you do decide to take one of these mortgages, shop around first. Borrow only the minimum amount that you need. You can probably take more later, so do not be persuaded to borrow more than is absolutely necessary. Talk to your financial advisor, lawyer or accountant, before you make a decision.

For more information on this topic, please contact the Rainey Collins office (04 4736850)
or the article author - Alan Knowsley.

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