David Koch: A reverse mortgage may (not) be right for you

If you’re over 60 and own your home, a reverse mortgage can allow you to tap into some of that hard-earned equity without having to sell or move out.

But there are both pros and cons to a reverse mortgage, and they can even have a long-term impact on your finances and family.

I always talk about the magic and power of compounding interest on savings… when you save for the long term, your balance benefits from the interest you previously earned.

This is a great incentive for your savings. But increasing the interest on your debt can be dangerous if you don’t understand the consequences.

Having said that, here’s why a reverse mortgage may make sense—or not—for your current financial situation.

What is a reverse mortgage? Simply put, a reverse mortgage is a loan that allows you to borrow against your home—without the need for regular payments.

Instead, interest accumulates over time and is only paid back when you sell your home, enter nursing care, or pass away.

The exact amount you can borrow will depend on factors such as your age, the value of your property, your lender and a few other details.

For example, if you’re 60 years old, you’ll be able to access about 15 to 20 percent of your home’s value; at 65, you can borrow about 20-25 percent.

Here’s where it gets interesting: you can take out the loan as a lump sum, a regular income stream, a line of credit, or a combination of the two.

Having some flexibility can help cash flow and finance things like medical expenses, renovations, or even increase your regular income—without the hassle of moving.

Why are you considering a reverse mortgage?

If you’ve retired and found that your super or pension simply isn’t enough to cover your living expenses, a reverse mortgage can help ease the stress. Many retirees simply move to a smaller home and profit from the transition.

But there are people who want to stay in their own home, and that’s where a reverse mortgage can be an option.

This is attractive if you want to stay in your home, but need to have a little more money on hand for immediate needs—whether it’s healthcare, increasing the comfort of your home, supplementing your lifestyle, or something else.

Let’s say you need funds to pay for home repairs or medical bills.

A reverse mortgage can give you the opportunity to get the money you need while still living in your home.

Plus, all reverse mortgages issued after September 2012 come with a bonus of negative equity protection, meaning you won’t owe more than your home is worth.

And this is a big problem. A reverse mortgage can end up eating up all the equity in your home.

So don’t jump just yet.

A reverse mortgage is not for everyone.

Pros and cons of reverse mortgages. A reverse mortgage may be the retirement lifeline you’ve been looking for, but it also has its downsides.

Be sure to explore both the advantages and disadvantages:

Pros

No recurring payments: You don’t have to make monthly payments while you live in your home, meaning your cash flow is free.

Payout flexibility: You can choose how you receive your funds: lump sum, income stream, line of credit, etc.

Stay in your home: Unlock the value of your home without having to sell or move, which is a huge plus for many retirees.

Cons

Compound interest: Interest is calculated on the loan amount and increases over time, meaning your debt can grow quickly.

Impact on retirement. Depending on how you use the funds, a reverse mortgage may impact your Age Pension eligibility, so be sure to check with Services Australia before making a decision.

Four important questions to answer:

Do I have other options?

Before you take on a reverse mortgage, consider whether there are other ways to access cash.

Could you be eligible for government benefits, interest-free loans or even consider redundancy?

A reverse mortgage should generally be a last resort since compound interest and long-term debt can catch up with you quite quickly.

How will this affect my family and inheritance?

Getting a reverse mortgage affects your property, which means it’s worth having an honest conversation with your family before signing on the dotted line. Explain how this works and talk about the potential impact on their inheritance.

What are the long-term costs?

Because interest increases over time, even a small loan can increase dramatically if not repaid. Lenders should give you a forecast of how the loan will affect your net worth over time, so take it to a financial advisor and review it in detail before making a decision.

Should I talk to a financial advisor?

Yes, it is worth seeking independent financial and legal advice. A financial advisor can tell you how credit can affect your future expenses, and a lawyer can help you understand the terms of the contract and the fine print.

If you’re considering a reverse mortgage, take the time to get expert advice and make sure it’s the right choice for your financial future.

After all, retirement should be about enjoying life, not worrying about your finances!