Moneyhub's Christopher Walsh digs deep in to reverse mortgages, what they are, their advantages, and their pitfalls and disadvantages. This is a full resource if you are considering one

This is a full and comprehensive review of reverse mortgages. Here is the executive summary:

• Reverse mortgages are also known as retirement equity release loans. They provide cash-up-front, with no repayment needed until you sell your home, move to a rest home or pass away.
• It's a common problem: you retire and have a mortgage-free house, but the New Zealand superannuation and personal savings don't cover the purchases you want to make. Reverse mortgages are pitched to retirees as 'zero-risk loans' that offer 'a better retirement' and 'guarantee you can unlock equity in your home while not having to sell it'.
• Applicants of reverse mortgages usually use the money for big cash items such as home repairs, a new car, an overseas trip to see family and/or debt consolidation.
• On paper, reverse mortgages sound attractive, but they are expensive debt; get it wrong and you can be caught out severely. Annual interest charges, usually between 7% and 8%, compound daily. It really is like taking out a big loan and not paying it back for years and years.
• If you change your mind later on and want to repay the reverse mortgage loan, as long as the interest rate is floating, the fees for doing this should be minimal or zero. Heartland Bank, for example, only offers a floating rate for reverse mortgages, and there are no penalties for early repayment.
• How expensive are reverse mortgages? Generally, if you borrow $100,000 at age 65, you will owe around $330,000 by the time you are 80. If you reach 85 and then need to sell your home and go into care, you will owe around $493,000.

Our guide to reverse mortgages outlines everything you need to know about this unique mortgage product. We cover:

• ​Know How Much You Can Borrow
• Advantages of Reverse Mortgages
• ​Disadvantages of Reverse Mortgages
• 8 Must-Know Facts about Reverse Mortgages
• Reverse Mortgage FAQs
• Conclusion

Know How Much You Can Borrow

For most lenders, the maximum you can borrow is 40% of your home's value. But lenders will limit the percentage based on your age - the older you are, the more equity you can borrow. This is because the chances of you passing away increase, so the risk for the bank of not being repaid from the sale of your house is lower. 

How is the 'value' of my home calculated?

When you apply for a reverse mortgage, a valuation fee is charged (usually $600+). This fee is paid to an independent valuer to assess how much your home is worth. If the valuer says it is valued at $500,000, then the bank will let you borrow a percentage of that based on your age.

How does my age affect how much I can borrow?

Heartland Bank states quite clearly that "your maximum loan entitlement can be estimated by multiplying the value of your home by a percentage (calculated as the age of the youngest borrower on your loan minus 45)". For example:
If you have a $500,000 home and the youngest borrower is 75 years old, then $500,000 X 30% = $150,000. 30% comes from 75-45 per Heartland Bank's calculation. 

The following table illustrates examples of this percentage at various ages based on this rule, although for other lenders it may vary slightly:

Age of Youngest Borrower	60	65	70	75	80	85
Maximum % of Home’s Value Available	15%	20%	25%	30%	35%	40%

As the table shows, the older you are, the more you can borrow as a percentage of the home's value. Keep in mind that the value of your home does not include its contents. Lenders will only loan based on the home value, which is made up of land and building only.

Advantages of Reverse Mortgages

Reverse mortgages have a number of benefits, which we outline in no particular order below:

1. You will receive a cash sum which you can spend any way you like.
2. The money you receive does not need to be repaid until your home is sold.
3. If house prices are increasing, this reduces overall loss in equity. For example, if you draw down $50,000 at an 8% interest rate over 10 years, and house prices go up an average of 6% per year over the same 10 years, your net cost of the loan is 2%. 
4. Depending on your age, you can draw down between 15% and 40% of your home's current value either all at once or in smaller sums as you need the money.
5. Some lenders guarantee you will never go into negative equity, so even if the loan balance exceeds your home value, you or your estate cannot be chased for the difference.

Disadvantages of Reverse Mortgages

Reverse mortgages are not without their risks, costs and drawbacks, which we outline below:

1. Reverse mortgages require you to stay in the home - if you want to rent it out and travel, sell it or need to move into care, you will need to sell your home and pay back the reverse mortgage loan owing.
2. Lenders charge higher-than-mortgage interest rates on reverse mortgages - currently around 8% where mortgage rates are 4% to 5%. This makes the arrangement relatively 'high interest'.
3. Because you don't usually make any repayments and interest compounds monthly, loans of $100,000 can blow out to around $492,000 in the space of 20 years. The longer you have the loan, the more you or your estate will owe. This can have serious implications if you need to move out of your home later and pay for residential care.
4. There are a range of fees charged, from upfront home valuation fees, application fees, drawdown fees and mortgage discharge fees - these together can easily top $2,500, and there are other fees that can be applied on top of these.  
5. You need to follow the rules of the reverse mortgage contract - this means you have to keep up with home insurance payments, pay council rates and look after it in accordance with the lender's guidelines.
6. Lenders are reluctant to offer reverse mortgages on some properties - examples are lifestyle blocks, farms, homes with a leaky building history, retirement villages and homes with troublesome monolithic plaster cladding systems.

8 Must-Know Facts about Reverse Mortgages

Reverse mortgages are complex and should only be entered into with a full and complete understanding of your obligations as a borrower. We have outlined 8 key must-know facts below to help you navigate the mechanics and fine print.

The interest rate is high, it compounds monthly, and because you don't make repayments, the balance you owe will climb FAST Reverse mortgages are not like standard residential mortgages. You are being advanced a sum of money, and the bank does not receive any repayment until you pass away or decide to sell your home. This can mean the bank can wait for 10, 20 or even 30+ years before being repaid. In this time, any money you have borrowed will incur interest. It's a higher interest rate than residential mortgages are offered, and it usually compounds monthly. Because you don't make any repayments, your debt can balloon.    In the table below, we show how much debt a $100,000 loan (with an 8% p.a. interest rate) can create. Once you borrow, the clock starts ticking on the interest expenses. As an example: If you were 60 and made a $100,000 drawdown, the money is yours to spend. If you move to a rest home at 90 the lender will claim back over one million dollars.  The $100,000 drawdown leads to a significant claim on your property so the risks need to be properly understood. Such a debt severely affects your long-term retirement plans. Age of Borrower Amount Owed at 80 Years of Age Amount Owed at 85 Years of Age Amount Owed at 90 Years of Age 60 $492,680 $734,018 $1,093,573 65 $330,692 $492,680 $734,018 70 $221,964 $330,692 $492,680 75 $148,985 $221,964 $330,692 80 N/A $148,985 ​$221,964

 

Be economical with what you borrow - i.e. if you only need $25,000, don't ask for $100,000 Because of the high (and compounding) interest rate, a reverse mortgage is expensive. For this reason, you should only draw down exactly what you need, and nothing else. For example, if you have a quote for $20,000 for home renovations, this is the amount you should draw down. Anything more than that is unnecessary and leads to excessive interest costs. You will probably pay a one-off fee per drawdown, but this will almost certainly be cheaper than leaving money in the bank that you don't need. If you apply to draw down $100,000 in total over the course of your retirement, taking it in portions as you need it is a very popular (and cost-effective method) to keep the borrowing costs under control.

 

Reverse mortgages by definition are a debt, and the debt has first dibs on your estate As soon as you draw down on a reverse mortgage, you create a debt. And unlike debts that banks usually offer, reverse mortgages do not get repaid until you pass away or sell your home. To be clear - you are not repaying it monthly or weekly. Because of the interest rates and effect of compounding interest which charges you interest on the interest previously incurred, any inheritance you plan to leave will be reduced by the amount of the reverse mortgage debt owed. While your house may have gone up in value every year, it's unlikely to outpace a reverse mortgage interest rate.  A typical example: Paul and Toni own a house worth $800,000 in Auckland. They borrow $100,000 at age 60 to spend on house renovations.  At age 85, they both pass away. Their home is now worth $1,500,000.  The reverse mortgage debt has grown to $730,000, and it takes another four months to sell the house, bringing the total debt to $750,000 (as interest continues to be charged until the house sells).  The estate of Paul and Toni receive $750,000 from the proceeds of the house sale ($1,500,000 sale price, less $750,000 reverse mortgage debt). The reason the estate and those inheriting only get half of the house proceeds is due to the high interest rate charged to the debt over 25 years, the fact the interest costs compound (so Paul and Toni pay interest on the interest costs) and the nature of reverse mortgages meaning there are never any repayments made until the very end.

 

There ARE alternatives to reverse mortgages A reverse mortgage is by no means the only option to get cash from your property; five popular alternatives might work for your needs: Downsize, and do it early. This frees up a lot of equity in your home, i.e. selling a four-bedroom for $800,000 and moving into a two-bedroom for $500,000 gives you $300,000 of available funds. And if you do plan to downsize, it makes sense to do it sooner rather than later. As you get older, it gets harder, and the likelihood you will do it decreases. While it may be overwhelming sorting out a lifetime of possessions as part of the process, invariably someone needs to do it. If you downsize early, you have more time to wait for the right offer for your existing home and house hunt for your next. Sell your home to your children. This gives you cash upfront or a steady income, and keeps your home in your family. Usually, this works by retirees receiving either the full value of the property upfront, or monthly payments which transfer more and more ownership as time goes on. Such arrangements need to be carefully planned with legal advice, as there have been cases throughout New Zealand where things have gone wrong, usually leaving the parents in a vulnerable position and often without a home. Consider a retirement home. Retirement homes are increasingly popular and offer a discounted property given the fact you never own the land. You will also pay a fixed ongoing weekly fee, have no repairs and maintenance costs, and you have the right to live there until you pass away or move out. But, retirement homes are not without their risks either, as our guide explains.   Consider renting out property within your home. Many homeowners don't want to move but are open to the idea of altering their home to create a self-contained flat which can be rented out. This has an upfront cost but does provide ongoing rental income (and the usual hassles of being a landlord).  Sub-divide any spare land your own: This is a possibility if you have a big section and would be comfortable with someone buying a portion of it and building a house. You will receive money upfront but also have the inconvenience of living beside a building site in the short term. It also drops the value of your property after the sale of the spare land.

 

If you sign up for a reversed mortgage, make sure your contract includes FOUR essential terms and conditions Firstly, if you are a couple, it is essential for BOTH of your names to be on the mortgage contract. This means that if one of you passes away or moves into care, your home will continue to be in the possession of the other person. Otherwise, it will be sold by the bank, which would make one person homeless.  Secondly, make sure the mortgage contract allows for 'lifetime occupancy'. This means that the bank cannot sell it for any reason other than your death or your need to permanently move out.  Thirdly, make sure the contract prohibits 'negative equity'. This means if you borrow, for example, $100,000, and later on the amount owed is $300,000 but your home is only worth $250,000, the bank cannot force your estate to pay any more money other than the proceeds from the sale of the home. Without this clause, the bank will have a right to any bank accounts, investments, vehicles and all other property of value before any beneficiary, i.e. those in the will.  Lastly, make sure the contract has a 'loan repayment guarantee' which means you never have to make any repayments until either you pass away or sell your home. For example, once you draw down the money you need, you never have to pay it back while you live in your home.

 

Besides the interest rate, reverse mortgages come with a lot of fees Your lender usually applies a lot of different fees before, during and after the reverse mortgage lifetime. In our example below, we've outlined the fees charged by Heartland Bank. ​Initial fees: Valuation Fee of your home: $600 (where rating value is below $1m) or $855 (where the value is above $1m or your home is a 'lifestyle property'). This fee can be deducted from your initial drawdown.  Initial Arrangement Fee: $1,275 (this is charged on the initial settlement date of your loan) and is deducted from your drawdown. Ongoing fees for further drawdowns: Express Top Up Fee: $125 - this is charged on, and deducted from, each drawdown you make. For example, if you request another $5,000, you will receive $4,875. Further Advance Fee: $450 - this is charged on the settlement date of a further advance to your loan, and is deducted from the advance you make.  End of mortgage fee: Mortgage Discharge Fee: $490 - this is charged at the time your loan is fully repaid (i.e. from the proceeds of the sale of your home). This fee is added to the loan balance of your loan and will form part of the total repayment required. In a typical example, if you borrow $20,000, $40,000 and then another $20,000 on a home valued at $600,000, you will pay the following fees: $600 valuation fee, $1,275 initial arrangement fee, $375 in three top-up fees ($125 each) and $490 for the mortgage discharge. The total cost is $2,740. Other fees that may apply depending on your circumstances: Equity Protection Option Fee: $58 - this is deducted from your initial drawdown if applicable Loan Variation Fee: $365 - this is charged if the terms of your loan are varied. Substitution Fee: $1,200 - this is charged if the lender approves the transfer of your loan to a new property.  Monthly Advance Set-Up: $125 - this is for a one-time set-up fee, charged at the time of the initial drawdown if you request a monthly advance. Administration Fee: $30 - this is charged each time the lender pays rates or insurance costs on your behalf. Agency Fee: $295 - this is charged if the lender needs to engage with an agent to obtain any documentation or information required for the purposes of your loan agreement. Please note that individual lender terms, conditions and fees vary - we have used Heartland Bank as an example given its dominant position in the New Zealand reverse mortgage market.

 

A reverse mortgage has a FLOATING (i.e. variable) interest rate, which may jump later on Reverse mortgages do not offer fixed interest rates given the length of the borrowing. Right now, interest rates are lower than they have been historically. If the Reserve Bank increases its cash-rate and mortgage interest rates increase overall, so will your reverse mortgage interest rate. 8% could easily become 10% or even 12%, meaning a $100,000 loan borrowed over 20 years could cost a whopping $732,000 and $1,089,255 respectively. Even if you have a guarantee of 'no negative equity', if you do need to sell your home later on, you would need to settle a big debt first.

 

Reverse mortgages can be dangerous if your circumstances change later on If you need to sell your home later on to buy a retirement home or rest home care, reverse mortgages can destroy the equity in your house. Our not-so-unusual example explains this best: Rod and Barbara take out a $100,000 reverse mortgage at age 65, paying an average rate of interest of 8% per year, with a house valued at $500,000. At age 80, they decide to sell their home and buy a retirement home for $350,000. By this time, their house can sell for $650,000. But, in the 15 years since they received the $100,000 reverse mortgage, the loan balance is now around $330,000, and this must be repaid to the bank when their house sells. Once the bank is repaid, they are left with equity of $320,000. Given the retirement home is $350,000, they have a $30,000 shortfall and will be unable to move. This outlines the risk of taking a reverse mortgage - it limits your options later on should your circumstances change. If you need to sell your home to pay for rest home care, you may not have enough to last more than a couple of years.

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Reverse Mortgage FAQs

What banks and lenders offer reverse mortgages?

The market is rather small, and two providers dominate the market. Presently, Heartland Bank (through its Seniors Finance division) and SBS Bank (sold as a 'retirement loan') are the go-to reverse mortgage lenders.

Are any types of homes excluded from reverse mortgages?

We confirmed directly with Heartland Bank that they consider all monolithic homes, and where the total land area is 5 ha or less.  Properties will also need to be valued at least $250,000.

Can I draw down a reverse mortgage weekly or monthly as a way to supplement income?

Yes. As an example, Heartland Bank offers monthly advances for a one-time setup fee of $125.  You can then advance an agreed amount sum of money every month for as long as you like.

Are all reverse mortgages the same?

No, but in our review we found very little difference by way of borrowing limits, interest rates and fees. If you decide to go ahead with a reverse mortgage, contacting ALL the lenders for their best offer is the ideal way to get the best deal.

How much interest do you pay on a reverse mortgage?

It varies by lender; generally it's between 7.00% and 8.00% per annum.

Does a reverse mortgage affect NZ superannuation payments?

No, whatever you draw down by way of a reverse mortgage is your money to spend as you like it. Your NZ superannuation will continue to be paid until you pass away.

Is a reverse mortgage a ripoff?

They can be - it really depends on the terms of the contract you sign. Media attention has made lenders less aggressive with fees, fine print and general terms and conditions.

Can you get a reverse mortgage if you owe money on your home?

Generally, no. You must be mortgage-free at or before your initial drawdown. In saying that, Heartland Bank confirmed that they do assist seniors who have small mortgages, and if there is a mortgage outstanding, it must be repaid when the reverse mortgage begins. This can be done by using part of the reverse mortgage available funds to clear the pre-existing mortgage.

Are there any safe reverse mortgages?

All reverse mortgages are 'safe' if they have a guarantee of no repayments during your time in the home, no repayments and a no negative equity guarantee. It is up to how much you draw down and how often you do it, which ultimately determines how 'safe' a reverse mortgage is. If you withdraw $100,000 on the day you retire but take 5 or 10 years to spend it, the interest costs will be significant. For this reason, savvy reverse mortgage customers draw down money from their lender only when they need it.

Are there application fees and termination fees on a reverse mortgage?

Yes - these vary but between lenders but can be as high as $400 to $500. The fee is added to the total loan balance and repaid by the house sale proceeds.

What is the best reverse mortgage?

It depends on the terms being offered. Generally, the most attractive deal is one with:

1. The lowest interest rate
2. The lowest fees
3. The best terms, such as life occupancy, no repayments and no negative equity, among others.

Can you lose your house with a reverse mortgage?

No - provided you ensure that your contract includes the FOUR essential terms and conditions in point 5 above. As long as you continue to live in it, the lender cannot force the sale of your home, even if your debt exceeds the current value of the home.

What happens to a reverse mortgage when you die or move permanently into care?

When you pass away, your lender has the priority security over the house and will organise for it to be sold. The net proceeds will be paid to your estate and distributed to your beneficiaries in accordance with your will. 

If you move into care, you will need to arrange for the sale of your home. Again, the bank will be repaid their debt as a priority. The amount left is yours to keep and spend how you will. For example, if your home sells for $600,000 and the bank is owed $200,000, you will receive $400,000.

How much equity do you have to have to qualify for a reverse mortgage?

Generally, you will need 100% equity, i.e. you own your home outright, before you can draw down any money on a reverse mortgage.

Can I rent out a room if I have a reverse mortgage?

Yes - but you cannot rent out your entire property and live somewhere else, as this will invalidate the terms and conditions of your reverse mortgage agreement. Renting one or two bedrooms, for example, while you live in the property is usually permitted by the lender.

Can you get a reverse mortgage at age 55 or 60?

Generally, the earliest you can draw down on a reverse mortgage is when you or your partner are at least 60 years of age.

Is there an upper age limit on reverse mortgages?

Yes, generally it is 90 years old - if you're older than this, lenders rarely offer reverse mortgages.

Does a reverse mortgage pay a lump sum?

It can, or you can take gradual payments. Bear in mind that each drawdown you make may be charged a one-off processing fee.

Do you have to pay taxes on a reverse mortgage?

No - because you are being loaned the money, there is no income tax on whatever you draw down from your lender.

Can you make monthly payments on a reverse mortgage?

Yes -  some lenders allow you to make repayments on your loan at any time, as well as fully repaying your loan. Check to see if there are early repayment charges with your loan, which have been reported in the past by the media. You will need to repay the Mortgage Discharge Fee if you do repay your loan in full. 

Do you pay interest on a reverse mortgage?

Yes. Interest is calculated monthly and added on to your loan balance. The interest then compounds, meaning your loan balance increases faster because you don't make any repayments and interest is charged on the previous periods' interest. The usual interest rate for a reverse mortgage is between 7.50% and 8.00% per annum.

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Reverse Mortgages: Our Conclusion

• We believe reverse mortgages should be a 'last option' given the long-term borrowing costs involved. We are also cautious about the various fees charged, which make this kind of financing very expensive. While retirement can be expensive (Moneyhub's retirement calculator gives you an idea), there are alternatives to reverse mortgages.
• If your circumstances change later on, a reverse mortgage can destroy the equity in your house, leaving you in a poor financial position should you need to move home or go into care.
• Be aware that the floating interest rate right now of 8% has room to increase, meaning even if you borrow at 8% now,  you may see the interest rate change to 10%, 12% or even higher later on.
• Right now, few lenders offer reverse mortgages - Heartland Bank and SBS Bank dominate the market. With such little choice, we believe the costs are higher than they should be. As mentioned above, alternatives to taking out a reverse mortgage do exist and should be explored fully. 
• If you do proceed with a reverse mortgage, make sure the terms are in your favour (i.e. no negative equity, the property can't be sold by the bank in your lifetime, no repayments in your lifetime and having both partners named are all essential). 
• It's best to talk to a mortgage broker and lawyer about reverse mortgages, as well as your family, given the risks involved. 

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Christopher Walsh is the senior researcher at MoneyHub, where this article first appeared. It is re-posted here with permission.