A retired couple needed to buy a new car.  Unfortunately, they had basically no cash and were just scraping by with their pensions each week.  

They owned a mortgage-free house in a popular Wellington suburb.

They had heard about 'reverse mortgages' or 'home equity release mortgages' and decided to make enquiries to see if they were appropriate for their situation.

What is a Reverse Mortgage?

Reverse mortgages (also called ‘home equity release mortgages’) are promoted as an option when you are in your retirement and do not have sufficient cash to cover things like:

• your everyday expenses;
• to carry out renovations to your house to suit your changed health situation;
• buy a different car; or
• to travel;

but you have a ‘freehold’ house/a house without a mortgage.  In other words, you are ‘asset rich’ but ‘cash poor’. 

The bank/lending institution will lend you money and put a mortgage on the title to your house.  Interest on the loan compounds over time and you pay the bank back once you sell your house, or your estate repays the bank when you pass away.  You don't have to make any on-going payments.

For many people their wealth is all tied up in their house, so this is a way to get that cash out, while still remaining in the house.  

There are pros and cons of such mortgages that it pays to be aware of.

Pros of a Reverse Mortgage…

• You can remain in your own home for longer (if lack of cash was the reason you were going to have to sell). 
• Provides you cash which would otherwise be ‘stuck’ in your house until you sell it.
• You won’t have to repay the mortgage until you sell the house or pass away.
• It’s one of the only ways to ‘borrow’ money in retirement as a bank won’t grant a normal mortgage or loan without the person having an income.
• In some cases, the banks will give you a ‘no negative equity’ promise which means you can never owe more than the equity in your house (i.e. you will never have to pay back anything more than the sale proceeds).   In other cases there is the option to protect some of your equity in other ways.
• Most banks promise you will never have to leave your house while the mortgage is still in place.
• Most banks allow early repayment of the loan, if you came into some money for example (although there will likely be fees charged for doing this).

Cons of a Reverse Mortgage…

• Higher interest rates, typically significantly higher than standard mortgage rates.
• Higher fees.
• The loan will eat into the inheritance of your children or other beneficiaries of your will.
• It will mean you receive significantly less money when your house is sold.
• It is a debt.  Your house will no longer be mortgage-free.
• You can’t transfer your house (e.g.: to children) while there is a mortgage on the title.
• If you live a long time, and then have to sell your house, or are forced to move out for health reasons, you may be left with very little to live on if all equity has been used up by the loan and interest.

Other Options

Reverse mortgages should generally only be considered as a last resort, where there are no other assets available for you to sell.

Other options include:

• Downsize/buy a smaller house and release some of your equity that way.
• Sell your house and move into rented accommodation.
• Rent out your house to tenants and rent somewhere smaller.       
• Obtain a loan from a family member (at a lower interest rate).  You can arrange for this to be repaid via your Will.
• Sell a part interest in your house to a family member.

The latter two options would require you to take legal advice, as you need to make sure you don’t trip yourself up in relation to any application you might make in the future for a rest home subsidy from the Government.

If you are in a situation where you are considering a reverse mortgage, you should talk to your financial adviser or accountant, as well as your family.  Before you sign a reverse mortgage you will also be required to take legal advice.