The difference between traditional mortgage and reverse mortgage
Traditional Mortgage
A mortgage is a process where you may use your property as security and borrow money in return from the mortgagee. One of its major uses is to allow people to buy property despite having limited cash flow. The person who mortgages their property (i.e. the mortgagor) is obliged to repay the loan and additional interest on a regular basis (usually monthly).
When the mortgagor has repaid all of the loan and interests, they will then be entitled to the full title of the property.
Reverse Mortgage
The core purpose of a reverse mortgage is to allow an elderly person to ‘cash out’ their home for expenses. At the same time, they can stay in their home until they move out or sell their home.
Contrary to the traditional mortgage, a reverse mortgage usually operates when the person who owns a home has an intention to cash out their home. The substantial difference between a traditional mortgage and a reverse mortgage is that the mortgagor does not pay back the loan, nor interests on a regular basis. The interest compounds over time and is added to the loan balance, and the whole debt is repaid when the mortgagor sells or moves out of their home.
The mortgagor’s equity in the property is, therefore, lost over a period of time. This is opposite to other mortgages where the loan is repaid to redeem equity. This is why the mortgage is called ‘reverse’.
What are the advantages of a reverse mortgage?
One of the most appealing features of a reverse mortgage is that it offers various combinations of money loan options. The mortgagor can take the loan as a lump sum, a regular income stream, a line of credit or a combination of these. The way in which the funds are distributed will depend on the mortgagor’s needs.
Another advantage is that the person who mortgaged their home will still be allowed to stay in their property when loan and interests are accumulating. This is a significant benefit, as compared with the traditional mortgage, where a mortgagor risks having their property taken away if they cannot make the repayments on time or at all.
Is it legal?
Yes, reverse mortgages are legal in Australia. However, since no income is required to qualify for the mortgage, there are restrictive regulations imposed on both the lender and the borrower. The operation of reverse mortgages is subject to the regulation of the Australian Securities and Investments Commission (ASIC).
Borrower
You must be aged at least 62 or above to qualify for a reverse mortgage. Unlike traditional mortgages that take into account your income and the value of your property or assets, the calculation of a reverse mortgage also considers factors such as your age and the future value of your home.
Lender
The lender is obliged to provide responsible lending to the borrower, which includes mandatory disclosures and the ‘no negative equity guarantee’ (NNEG).
Mandatory disclosures include the obligation to inform the borrower of how the reverse mortgage works and its projections. The lender is obligated to ensure the borrower understands how the reverse mortgage may affect them and their home. NNEG means that the borrower cannot owe more than the market value of their secured property when it is sold. Lenders must return any amount paid in excess of the market value.
Is it a wise choice?
Reverse mortgages are a special kind of mortgage that are designed for a specific group of people. It could be a life-saving option to some people, but a regretful for others. The suitability of a person depends on the actual circumstances of each case.
Below are some potential factors that may be relevant to deciding whether it’s the best option for you:
- Your age and if you have any health conditions;
- Whether you have any heirs or issue (children);
- Whether you have other tenants living in your property;
- Your eligibility to receive a pension.
As reverse mortgages remain a controversial topic all over the world, you must weight up the benefits and disadvantages before mortgaging your home. You should always consider whether the mortgage can provide an outcome that is best for you, and whether you can afford the potential risks. Suffice it to say, it’s always a smart move to consult a property lawyer before deciding to enter into any sort of mortgage.
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