Most Australian wealth is locked up in housing. While it is the largest asset for many Australians it cannot be converted into income if you are living in it. A house must be sold in whole to release the funds.

A primary residence serves dual purposes – it may be an asset, but it is also your home. Many people in retirement struggle to downsize or move to a less expensive part of the country. A house is full of memories, provides comfort and places a homeowner in a community.

As longevity increases and cost of living pressures persist, more retirees are looking for ways to unlock the capital in their home without selling it. One option is a reverse mortgage.

Reverse mortgages can be a powerful tool to increase cashflow for retirees, but they also come with trade-offs that require careful consideration.

What is a reverse mortgage?

A reverse mortgage is a loan available to older Australians (typically 60 years and over) that allows them to borrow against the equity in their home. Unlike a traditional loan, there are no required regular payments. Instead, the interest compounds over time and the loan is repaid when the borrower sells the home, moves into aged care or passes away.

In simple terms, it converts part of your home equity into cash – either as a lump sum, regular income stream, or a line of credit.

How it works

The amount you can borrow will depend on the value of your property and your age. The older you are, the more you can access. At 60, you can generally access around 15-20% of your home’s value with the percentage increasing with age.

Interest rates on reverse mortgages tend to be higher than standard home loans. They are currently around 7-9% p.a. Importantly because you’re not making repayments, the interest compounds and the loan balance can grow quickly over time.

For example, if you borrow $100,000 at a 7% interest rate, the loan could roughly double in 10 years if no repayments are made. The compounding effect is one of the key considerations when considering this strategy.

Reverse mortgage compounding interest

Image: The compounding effect on a $100,000 withdrawal from a reverse mortgage.

Bad experiences have led to stronger protections

Some retirees have steered clear of this strategy because of the damage they caused in the 1990s and 2000s. Earlier generations of retirees often experienced the downside of reverse mortgages where the compound interest ate away at home equity at a time when there were no safeguards for negative equity protection. This meant that borrowers or their estates could end up owing more than the value of the home.

Some retirees lost the whole value of their homes which represented wealth they spent a lifetime building. Estates were wiped out, and some surviving spouses faced significant financial stress. This caused lasting stigma around reverse mortgages.

However, there are now protections for retirees that did not previously exist. They include regulations and important consumer protections such as:

  • No Negative Equity Guarantee (NNEG): You can never owe more than the value of your home when it is sold.
  • Mandatory independent legal advice: Lenders need to ensure that borrowers understand the implication, so independent legal advice is a requirement for most reverse mortgages. A qualified lawyer reviews the contract and explains the implications of partaking in the strategy,
  • Equity protection rules: There are limits on how much can be borrowed based on age.

These safeguards are designed to prevent the worst-case scenarios that plagued earlier versions of these products. However, these protections do not negate the due diligence retirees need to do to ensure that this strategy is for them.

The pros and cons of a reverse mortgage

There are always a lot of advantages to accessing extra cash. You can supplement your retirement income, fund health care, help family members or maintain your lifestyle.

This must be weighed against the gradual erosion of your home equity. This leads to several implications:

  • Impact on inheritance
  • Reduced financial flexibility in the future, particularly if funds are needed for aged care
  • Potential impact on government benefits as depending on how it is held, a reverse mortgage can impact Age Pension entitlements

When does a reverse mortgage make sense?

A reverse mortgage works best when used strategically, instead of a last resort. A reverse mortgage can suit retirees, particularly in the following situations.

  • You want to stay in your home long-term
  • You have significant home equity but limited cashflow
  • You understand and accept that there will be an impact on the inheritance that you leave
  • You have explored alternative options and believe this is the best strategy

For example, a retiree with a valuable home but modest superannuation may use a reverse mortgage to draw a small income stream that helps smooth consumption over retirement without drastically reducing equity.

What are the alternatives?

Before committing to a reverse mortgage, assess your alternatives.

Downsizing

Selling your home and moving into a smaller property can free up capital while reducing ongoing costs. The government’s Downsizer Contribution Scheme also allows you to contribute proceeds into superannuation (based on their eligibility criteria).

Using superannuation more efficiently

Understand your withdrawal strategy in superannuation and whether you need to adjust your asset allocation to make it more optimal for your retirement. This could include utilising the bucket strategy to increase the longevity of your portfolio.

Home Equity Access Scheme

The Home Equity Access Scheme is a government initiative that allows eligible retirees to receive a government backed income stream using their home as security. The interest rate is much lower than reverse mortgage options through private lenders. The current rate is 3.95% per annum. You must qualify for the scheme, based on your income levels and other eligibility criteria.

Final thoughts

Reverse mortgages sit at the intersection of two competing priorities – maintaining quality of life and preserving wealth.

For some Australians, they offer a practical solution to a real problem – how to fund for a longer retirement without sacrificing independence and the family home.

As Australians continue to build wealth in their homes, reverse mortgages will play an important role in retirement planning.

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