Reverse mortgages and other equity release

gco_image of homeNote that the information appearing on this page has been written for the State of Victoria, Australia, although it generally applies to other States as the relevant law is not State based.

Who will be interested in the information on this page?

Any senior borrower seeking to release “loan” funds on the security of their home but would not qualify for a normal (bank) loan because they are not an income earner.

What is “equity release”?

It is a general term for various forms of “loan” advances which do not involve immediate repayment of either the principal or interest, and which are advanced on the security of the equity (ownership) of your home.

What is a reverse mortgage?

Again, this is a general term for various forms of equity release.  It is a somewhat misleading term, but it basically refers to equity release advances in relation to which principal and interest does not have to be repaid immediately, only on the occurrence of some future event, for instance, when the property is sold.

(A mortgage itself is just a special form of loan – monies are advanced on the basis that security is taken, by way of a mortgage, on real estate owned by the person seeking the loan or owned by someone else, and the real estate can be sold if there is default under the loan.)

What forms of equity release are there in Victoria?

The two most common forms of equity release/reverse mortgage in Victoria are, first, what we will call reverse mortgages, and secondly, the Homesafe product.  We will deal with each in turn.

Reverse mortgages

The reverse mortgage type of equity release is the most common and uses the word “mortgage” because, ultimately, principal and interest have to be repaid.

The average advance for the reverse mortgage type of equity release is about $70,000, but is often more or less than this.  They are typically advanced to the senior citizen, who owns his, her or their own home and cannot obtain a normal loan because they are not working.  Loans are typically advanced on the basis of between 15 and 25% of the markedt value of the property.  The advanced monies are typically used for home maintenance, to buy a car or have a holiday, to pay for educational expenses for grandchildren, a combination of these, or for similar purposes.  The monies advanced can either be taken as a lump sum, or drawn upon when needed.  Sometimes they are drawn down in regular amounts like a pension.

A reverse mortgage is really exactly the same as a normal mortgage with the exception that nothing is repaid (principal or interest) until some future event occurs.  This future event would typically be the sale of the property.  A mortgage is registered on the property, just as a normal mortgage would be.

The principal difference between a normal mortgage and a reverse mortgage is that the interest accruing on the loan is added to the loan, not repaid on a regular ongoing basis.  So, for instance, if the initial loan advance was $100,000 and the interest rate was 5%, then the principal at the very start of the loan is $100,000, but at the end of the first year would be $105,000, with the interest added.  Accordingly, after the first year, interest then has to be paid on the increased principal.  It is said that the interest is “capitalised”.

The Homesafe product

This product is fundamentally different than a reverse mortgage in that the ultimate repayment is not based on the principal and interest that might normally accrue on the advance that is given.  In fact no interest whatsoever accrues on the advance, and issues of capitalisation of interest and compounding interest (that applied to reverse mortgages) are not relevant.

What is involved in the Homesafe product is an agreement that in exchange for the advance made the homeowner/borrower agrees that Homesafe is entitled to a certain fixed percentage of the sale price of the home when it is sold.

So, the typical life-cycle of the Homesafe product is – Homesafe approves and advances a fixed sum of money to the homeowner/borrower on the agreed basis that it is entitled to take 30% of the sale price of the property when it is sold, Homesafe places a mortgage on the property, no repayments are made, the homeowner some years later wishes to sell the property or has to sell the property because of health reasons, and from the net proceeds of sale the homeowner/borrower takes 70% and Homesafe takes 30%.

Are equity release/reverse mortgage/Homesafe products safe?

As long as borrowers fully understand what these products are and borrowings represent a modest percentage of the value of the home, and, very importantly, financial advice and legal advice is sought, these products can serve a useful purpose in many instances.

There is an organisation called SEQUAL (Senior Australians Equity Release) – www.sequal.com.au

Anyone considering equity release should look at this website – it has a great deal of useful information.  Moreover, members of SEQUAL comply with a code of conduct in relation to equity release products.  Those organisations who are members, are listed on the site.

What are the dangers of equity release/reverse mortgages?

There are a number of important things that should be taken into consideration.  The following comments generally apply to the reverse mortgage type of equity release, not the Homesafe product (as Homesafe acts under fairly strict lending protocols, and, issues of accumulating interest do not arise).

It is important not to borrow too high a percentage of the value of your property.  The members of SEQUAL will generally lend on modest percentages.  The danger in lending on high percentages of the value of the property is that accumulating and compounding interest will quite rapidly eat up all of the equity in the property and the borrower may be liable not only for what can be realised from the sale of the property, but also any shortfall that may arise because the accumulated loan and interest is greater than the sale value of the property.

This problem could be magnified if either property values decrease/do not increase over ensuing years, or interest rates substantially increase, or a combination of both.

This leads to the very important principle of “no negative equity guarantees”. All SEQUAL members have to provide a no negative equity guarantee.  This simply means that even if the accumulating loan and interest exceeds the value of the home when it is sold, they will only recover the net proceeds of sale, nothing more.

This guarantee forms part of the lending contract in SEQUAL loans.

Another principal danger with these loans (and indeed any loan) to a senior person, is that pension entitlements might be affected.  Again, it is critically important that specialist financial advice be obtained about this.

Also seek advice from professional advisers as to whether you can pay off the loan at any time, and if so what costs or fees might be involved in doing this.

What other considerations should be taken into account when thinking about a reverse mortgage/Homesafe/equity release?

Again, there are a number:

  • Look at alternatives – although these products do have their place used wisely, banks and other lenders are profit driven and these products are costly in the long term.  Because children will, to some extent, be disinherited to the extent of the liability to repay the reverse mortgage, it may sometimes be possible to borrow funds that are required from children or other family members.
  • Rather than take out a reverse mortgage is it possible to release equity yourself by selling and purchasing a less expensive property?
  • Discuss with children/family members your intention about the reverse mortgage and what it may mean for them.
  • Will there be sufficient equity in your home after repayment of the reverse mortgage if it is necessary to pay an accommodation bond (or other costs) in an aged care facility?  Again, this emphasises the importance of obtaining specialised financial advice.
  • Ensure that you do not fall foul of default provisions in the loan contract.  Default can lead to increased interest rates having to be paid, other penalties, loss of no negative equity guarantee provisions, and forced sale of the property.  Typically, reverse mortgage contracts provide that you must keep the property in good condition, not lose possession of the property (by, for instance, renting it), keep up to date with rates payments and other outgoings, not leave the property vacant for long periods of time, and ensure that your fire and other risks insurance policy notes the interest of the reverse mortgage lender.  This list is not exhaustive.
  • Draw down on the advance only when necessary rather than take the full amount at the start – in a reverse mortgage interest only accumulates on what has actually been drawn down.
  • Be careful if you are seeking a reverse mortgage loan from a non–SEQUAL member.  Part of the SEQUAL code of conduct is that the borrower must first obtain both legal and financial advice.
  • Be aware that once the reverse mortgage or Homesafe interest is secured on your home by mortgage, you will not be able to place further mortgages or other encumbrances on your title – this would generally involve a default under the respective contracts.  Moreover, reverse mortgage and Homesafe interests have to be a first encumbrance on your title – any existing mortgage (or caveat) would have to be discharged/paid out/refinanced.
  • Look on the Internet for reverse mortgage calculators – they give a good visual representation of how interest accumulates over a chosen period of years and how this affects the equity in your property.  You can compare various scenarios of different interest rates, initial borrowings, increase in property values, et cetera.
  • Are you under some duress from a family member, or other person, to take out a reverse mortgage to pay out a debt, or to pay the monies for some other purpose?  Seek legal advice without that person being present.
  • If you are a child or a friend of a person who you know is taking out a reverse mortgage for improper purposes, for instance to gamble, try and persuade them not to do so.  Consider going to VCAT to obtain an administration order if there is any dementia or other psychological or other disability present.
  • Try not to have family members who are powers of attorney sign reverse mortgage documentation on your behalf – take control of the transaction yourself and get your own independent legal advice.
  • Be mindful that traditional increases in property values may not occur in the future, and that interest rates may increase substantially in the future.

The Homesafe product and the various forms of reverse mortgage – is one better than the other?

This will depend entirely upon your own specific financial circumstances, the value of your home, whether your home presently has a mortgage on it, whether you are in receipt of a pension benefit, and other considerations.  Financial advice should be obtained about this.

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Peter Gauld.

The Principal, Peter Gauld LL.B, has been a practising solicitor in Melbourne, city and suburbs, for thirty years.

He has a keen interest in the legal issues that affect the senior citizen.

He is, amongst other things, a member of the Elder Law Section of the Law Institute of Victoria and a volunteer Community Visitor for the Office of the Public Advocate.

He holds a Bachelor of Laws degree from the University of Melbourne, graduating in 1978.

He has a background in litigation.