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Reverse Mortgage Pitfalls Are Overstated

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Journalists comments about reverse mortgage pitfalls can be very distasteful - until we have come to realise that some people really don't have any other option.  

Reverse mortgage loans are also known as  equity release loans, but I like to focus on reverse mortgage pitfalls because when the bank pays you each month (rather than you paying them each month when you are paying off a mortgage) they aren't doing it to be charitable.   No way.

To a bank it's just an unemotional financial transaction. So the dangers of reverse mortgages do exist just because it's a very uneven playing field.

However the disadvantages are oversold - if you don't have an option, why not use that equity under your floorboards?

if you've now realized that your maximum social security benefit will never be enough, and you're desperate, you may not have any other option.

How Reverse Mortgages Work

A reverse mortgage allows you to borrow money from a bank or other financial institution using the wealth "under your floorboards" - but your withdrawals are limited to 40% of value.  So you can never lose your family home.    

Your own family home is used as security. However, if you can, don't spend it on consumer items.  Ideally, you would use this money to buy a one person business, as not only will you then have an income, but the mental and health benefits are also substantial.

You can draw down your loan as a lump sum, or perhaps as regular income stream, or a line of credit or any combination.

These loans are attractive to retirees as you don't need an income to qualify. However, while interest is charged like any other loan, you don't have to make repayments while you're still living at home - the interest compounds over time (actually rapidly over time) and is continually added to your loan balance.

So you remain the owner of your (heavily mortgaged) house and you can stay there for as long as you want. The loan becomes payable in full (including interest and fees) should you sell your home to move into a retirement village, when your "estate event" occurs or, in most cases, if you move to an aged care facility.

How Much Can You Borrow?

Of course there are reverse mortgages pros cons and generally you can borrow from 15% to 40% of the value of your home - but this depends on your age. The older you are, the more you can borrow, because there is less time for the relentless march of compound interest to outgrow the value of your home.

The maximum loan will depend on the value of your property on the date when you borrow. However if you need the money, I would suggest that you the maximum now, as you will not have the capacity to borrow again later - as the rate of interest will always exceed the annual capital appreciation of your home.

The is an exhaustive discussion about reverse mortgages pitfalls - and benefits - on     Go there after you have finished with this general information page that you are now reading.

The Actual Financial Impact

Compound interest is relentless.

For example, over 15 years a loan of $50,000 will become almost $240,000 at 11% over 15 years. And 11% is what you may be required to pay. 

This is very concerning to me because you may have to start with these reverse mortgage pitfalls when you're say 65.  In 15 years time you will only be 80!  And remember, with our retirement age life expectancy continuing to edge out, many of us will now be living into our 90s.

Similarly, if you lived until 95, your original $50,000 loan will have become in excess of $1,000,000 over 30 years.  Wowee! 

Alternatives - to avoid those reverse mortgage pitfalls

I you have the time and motivation, you could develop alternative streams of income, such as

(1) various retirement income strategies

(2) rent out a bedroom

(3) a genuine work-from-home online business using such technology that is available from Sitesell.

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