Reverse Mortgage Loan Blog

In his retirement years Uncle Bill lived in a modest bungalow in Spreydon, Christchurch. After Aunty Mona’s death he forged a close relationship with our three children, and we saw a lot of him.We knew that Bill did not have much to come and go on, and he constantly complained about his bank mortgage.

It was only about $20,000, but his income was little more than the pension, and clearly the cost of servicing the mortgage was a drain on his resources.

Eight years ago Bill read an advertisement about a new loan product on the market, the reverse mortgage.

This was described as a loan facility tailored for the retired, where you borrow on mortgage but are not required to make loan repayments.

Instead, interest on the loan is added to the loan debt and is repaid when eventually you die or sell your home.

This sounded to Uncle Bill just what he wanted. He found out everything he could about reverse mortgages, and then asked me for my opinion.

We pored over the paperwork together. The loan facility was fully explained.

As long as you continue to adequately maintain your home (so that its value is not impaired), pay your rates, and keep the home fully insured, you are not required to make any loan repayments until you eventually sell the home, or die.

The loan can be taken either in a lump-sum payment, through a credit line where you draw down as you choose, or on an instalment option, where you can elect at intervals to draw down lump-sum payments.

We noted the advice that interest rates on reverse mortgages tend to be up to 2 per cent higher than current bank rates.

One matter we wanted to clarify was that Bill’s loan would have “negative equity protection”. This means that if, at the time of sale of the property or Bill’s death, the loan debt is greater than the value of his home, neither Bill nor his estate would be required to make up the shortfall.

Bill liked the look of this idea. He took out a reverse mortgage with one of the leading institutional lenders.

He borrowed not $20,000, but $35,000, and used the extra money to replace his ageing Hillman Minx motorcar.

On many occasions over the next few years he told us how pleased he was that he no longer had to service a bank mortgage, and how this helped him in his daily budgeting.

Then disaster.

All went well until Bill suddenly suffered a health problem. He collapsed one evening when working in the garden at home and was admitted to hospital.

The prognosis was that he needed heart valve replacement. However, at his age Bill came well down the priorities list.

He was not eligible for state funding for expensive surgery - which, in the eyes of those who determine priorities, was more aimed at improving his quality of life, rather than preserving it.

His name never seemed to get elevated sufficiently to make him eligible for surgery.

His health continued to deteriorate to the extent it was judged best that he move to Nelson to live near his daughter.

But here was the rub. A little over eight years had passed since he had taken out his reverse mortgage loan.

His property in Spreydon now had a market value of about $220,000. However, the mortgage debt, with accumulated interest and other charges, had grown over that time from $35,000 to almost $90,000.

The resultant equity in the home of $130,000 was simply not enough for Bill to be able to finance his way into a home, even a modest ownership flat, in Nelson, where prices seemed to be extraordinarily high.

Bill approached his reverse mortgage lender to see if anything could be done, but it was not in a position to help. What was he to do?

Uncle Bill’s case highlights two aspects of reverse mortgage borrowing.

The upside is the benefits the reverse mortgage can give homeowners, who have substantial equity in their home but whose income is not sufficient to allow the lifestyle they enjoyed before retirement.

These benefits are very real to the retired person who would otherwise have a mortgage to service.

Standard trading banks are no help here. They like mortgages to be repaid, and, in the main, are not in the market for lending on the never-never.

For Uncle Bill, the reverse mortgage gave him immediate disposable income. This should not be lost sight of. He was able to enjoy eight years of enhanced retirement.

However, the downside of the reverse mortgage is the cost of the borrowing. This can eat up capital pretty rapidly, and equity in the home can just disappear.

In part, this is because interest rates on reverse mortgages are higher than standard home mortgage rates. But, in addition, interest is compounded. It is added periodically to the loan balance, and the loan debt compounds and grows.

The longer the borrower lives in his home, the more the debt grows at an ever-accelerating rate.

If you are contemplating a reverse mortgage, look for these features:

* Portability. The loan must be able to be transferred to another property. There can be any number of reasons why a settled home owner might later want to change address. Uncle Bill’s case was just one possibility.

On the transfer of a loan, the borrower must be prepared to accept that if the new property is of a lower value, some repayment of the loan balance (out of the sale proceeds of the existing home) might be required.

* Negative equity guarantee. Ensure the lender offers a negative equity guarantee - that is, a guarantee that on eventual repayment of the loan the borrower will not be required to pay more than the value of the property. Lenders can take out insurance to protect themselves against this eventuality.

* Eligibility for additional borrowing. Ensure there is eligibility for further borrowing later, at least in those cases where the equity in the property is sufficient to allow this. You never know what lies around the corner and when you might need access to additional capital.

* Limit your borrowing. Was Uncle Bill wise to borrow to buy a car? Perhaps not. Because of the high cost of borrowing on reverse mortgage, delay drawing down as long as you can and draw down only the minimum you need.

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