Question:
Please could you fully explain reverse mortgages to me? Also, what are the pros and cons?

Answer:
Reverse mortgage is exactly that ? a home loan in reverse! Instead of taking a loan out at a bank to buy a house (and until it?s paid for the bank owns it), a loan is taken out against a house you own with the end result being that the house no longer belongs to you but to the bank.

In the same way a bank charges interest on a home loan, interest will be charged on a reverse mortgage; whatever the capital loan amount is multiplied by an interest rate set by the bank. It is very similar to an access bond where a person can access a portion of the capital they have already paid off on their home loan. As with any loan, it has interest costs and has to eventually be paid back!

So how does a reverse mortgage work? People who own their own home and have no mortgage bond (maybe a low bond amount will be considered) and are 65 years of age or older may apply. The thinking behind it is that it usually takes 20 years to pay off a home loan so in reverse an income could be paid by the bank to the owner for about 20 years, by which time a 65 year old is statistically expected to no longer need a home.

In a deceased estate situation the bank would claim the home, sell it and any value left over would be paid to the heirs. In practice the bank will only lend the money for five years at a time. After each five year period the loan needs to be re- negotiated, but this is a mere formality just to check on the condition of the house, etc.

If the loan is for a portion of the current value of the house, over 20 years, one would expect that the house will continue to appreciate in value so that either further loans could be applied for over time or the heirs still get some sort of inheritance at the end of the owner's life.

So, what could go wrong? Well, the owner has the option to take the loan as a lump sum upfront instead of a monthly withdrawal. If they do that and spend all the money (for example on a new business venture that goes bust) they then sit with a loan that needs repaying and the only way they can repay it is to sell the house, leaving them homeless and with no further income.

Even if they opt for a monthly withdrawal, thereby increasing the loan amount (and naturally the interest on it) slowly, over time it will all add up. Remember the bond interest does not get serviced so it keeps on adding to the existing loan.

A case could arise where the property markets fall drastically and the loan outstanding is more than the value of the house (history is notorious for repeating itself!). Where would a pensioner get the money to cover the excess debt? And what if the owner lives for another 30 years or more?

In theory, it does sound like a nice idea for people struggling to make ends meet in their old age. In practice it can get complicated so please, as always, be ultra careful when considering this option. Do your sums properly! And if you are you not financially minded, please consult with someone who is. You guessed it, a qualified financial planner!

acsis Limited is an authorised financial services provider. The response to the question covers some of the issues in a general and factual manner and does not constitute advice. It is important to consult with a financial planner who, after an analysis of the individuals? personal needs, goals and circumstances, will be able to provide comprehensive and appropriate advice.