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Reverse mortgages

Feb 01, 2011

We own our house but rely on the pension for income. We would like to take out a reverse mortgage for $100,000 to renovate our bathroom, buy a car and give our daughter $30,000.  Is this OK?  Eileen, Qld

The "reverse mortgage" product was devised by banks for those over 60 who could borrow up to 40%  against their home but didn’t have to make any repayments. 

Lovely banks?  Don't kid yourself!  Banks are never generous with their money.

Some things in life are simply too good to be true.  And reverse mortgages definitely fit in this category. 

The loan must be repaid when you move out to aged care accommodation or if you die, usually out of the proceeds of the sale of your home. 

Fees and interest (usually higher than home loan rates) are added to the loan balance.   Over time, you're charged interest on the interest (known as compound interest) and that builds up the total amount you owe. 

The effect of compounding interest can be extremely dangerous to your financial health. 
$100,000 borrowed today increases to $226,098 in ten years’ time at 8.5% interest.  And it jumps to $511,204 in 20 years' time.

If house values increase by only 3.5% each year but the loan interest is 8.5%, then any equity that you have in your property will quickly start to narrow.

Please be cautious about the calculators provided by reverse mortgage providers as they generally only show how much you can borrow and not how much you have to repay.

You may not have enough to pay for aged care accommodation or to leave an inheritance (although you can protect a fixed percentage of the value of the property so it cannot be used to repay the debt).

There is also a risk that the loan may rise higher than the value of your home.  Get a "no negative equity guarantee" where you don’t have to repay beyond your home’s value.  This protection may be lost if you don't meet certain conditions, such as maintaining your home to a standard set by the lender.

Aside from the perils of reverse mortgages, your plans may also have a negative impact on your pension.  Centrelink will assess your car as an asset as well as $20,000 of the money given to your daughter based on gifting rules.

Tags: Financial PlanningProperty

Author: Mr Taxman

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