Can You Use a Reverse Mortgage to Pay Off an Existing Home Loan?

An eligible older homeowner may be able to use funds from a reverse mortgage to repay an existing home loan, subject to lender requirements and having sufficient home equity. The existing mortgage will generally need to be repaid or refinanced as part of the transaction. A reverse mortgage does not eliminate the debt; it replaces or restructures it, and interest and fees can accumulate on the new loan balance over time. Eligibility, borrowing limits, costs and conditions vary between lenders.

What Is a Reverse Mortgage?

A reverse mortgage is a type of loan generally designed to allow eligible older homeowners to access some of the equity they have accumulated in their home. The property is used as security for the loan. Unlike a conventional principal and interest home loan, regular repayments are generally not required, subject to the terms of the particular reverse mortgage. Instead, interest and applicable fees may be added to the outstanding balance. If interest is not paid as it accrues, the balance can grow over time through compounding. The loan eventually needs to be repaid in accordance with the credit contract. For more information, read How Does a Reverse Mortgage Work in Australia?.

Can You Get a Reverse Mortgage If You Still Have a Mortgage?

Having an existing home loan does not necessarily prevent a homeowner from being considered for a reverse mortgage. However, the amount still owing on the existing mortgage is an important part of the assessment. A reverse mortgage lender will generally consider the property’s value, the existing debt, the applicant’s age and the amount of equity remaining in the home. Where an existing mortgage is secured against the property, it will generally need to be dealt with as part of establishing the reverse mortgage.

How Can a Reverse Mortgage Pay Out an Existing Home Loan?

If a reverse mortgage application is approved and sufficient funds are available, some or all of the proceeds may potentially be used to repay the existing mortgage. For example, a homeowner may have a property with substantial equity but still owe money on a conventional home loan. Subject to eligibility and lender requirements, the reverse mortgage could potentially provide funds that are applied towards discharging that existing loan. The homeowner would then have the reverse mortgage secured against the property rather than the previous home loan. This does not mean the debt has disappeared. It means the debt has been refinanced or restructured into a different type of lending arrangement.

You Need Sufficient Home Equity

Home equity is central to reverse mortgage lending. Equity is broadly the difference between the property’s value and the amount of debt secured against it. However, having equity does not mean the entire amount can be borrowed. Reverse mortgage lenders generally limit how much of a property’s value an eligible borrower can access. The permitted amount may depend on the borrower’s age, property value and lender criteria. If the existing home loan balance is too high relative to the amount available under the proposed reverse mortgage, there may not be sufficient proceeds to repay it completely. You can also read Understanding Home Equity: How Sunshine Coast Homeowners Can Leverage Their Investment.

What Happens to Your Existing Mortgage?

Where a reverse mortgage is being used to refinance an existing home loan, arrangements will generally need to be made to discharge the current mortgage. This typically involves confirming the payout amount required by the existing lender. The reverse mortgage provider may then require sufficient funds to be directed towards that debt as part of settlement. There may also be discharge, establishment, valuation, legal or other applicable costs associated with changing loans. The exact process and costs depend on the lenders and loan agreements involved.

Will You Still Have to Make Monthly Repayments?

One reason some homeowners investigate reverse mortgages is that regular repayments are generally not required in the same way as with a conventional home loan, subject to the specific loan terms. However, not making regular repayments does not mean there is no cost. Interest continues to accrue on the amount borrowed. If the interest is added to the loan balance rather than paid, future interest can also be charged on the accumulated balance. This compounding effect means the amount owed can increase over time. Borrowers should understand the potential long-term cost rather than focusing only on the absence of regular repayments.

What Happens to Your Home Equity?

Using a reverse mortgage to repay an existing home loan can affect the amount of equity remaining in the property. The balance of the reverse mortgage may grow as interest and fees accumulate. Unless property value growth or repayments offset that increase, the proportion of the property represented by debt can rise over time. This may leave less equity available later in life or reduce the value of the estate ultimately available to beneficiaries. Future property values cannot be predicted or guaranteed, so borrowers should consider how different scenarios could affect their remaining equity.

What Is Negative Equity Protection?

Australian consumer credit law includes negative equity protection for qualifying reverse mortgages entered into from 18 September 2012. Broadly, this protection limits the amount that can be required to be repaid when the mortgaged property is sold in accordance with the relevant legal requirements, so that borrowers are generally not required to repay more than the property’s market value. Specific conditions apply, so borrowers should obtain appropriate advice about how the protection operates for their particular reverse mortgage. Negative equity protection does not stop the loan balance from increasing and does not guarantee that a particular amount of equity will remain in the property.

When Does a Reverse Mortgage Need to Be Repaid?

Reverse mortgages are generally repaid when a specified event occurs under the credit contract. Depending on the loan terms, this may include when the property is sold, when the borrower permanently leaves the home or following the death of the borrower. The exact repayment triggers and timeframes should be clearly understood before entering into the loan. This is also an important consideration for family members and anyone involved in the homeowner’s estate planning.

Compare the Existing Loan With the Proposed Reverse Mortgage

Replacing a conventional home loan with a reverse mortgage changes how the debt operates. The comparison should therefore involve more than looking at whether regular repayments will still be required. Interest rates, fees, compounding, expected loan duration, repayment conditions and the potential reduction in home equity should also be considered. A reverse mortgage may have different rates, fees and long-term costs from a standard home loan. Replacing one loan with another does not automatically result in a financial saving.

Are There Alternatives to Consider?

A reverse mortgage is one potential way for an eligible homeowner to access home equity, but it is not the only possible option. Depending on individual circumstances, alternatives might include continuing with the existing home loan, refinancing through another conventional loan, using available savings, downsizing or considering other financial arrangements. Not every alternative will be available or appropriate for every homeowner. Comparing the potential costs, risks and consequences of different options can be important before making a decision.

An eligible homeowner may potentially use a reverse mortgage to repay an existing home loan, but sufficient equity and lender approval will generally be required. The key point is that paying out the existing mortgage with a reverse mortgage does not eliminate the underlying debt. Instead, it changes how that debt is structured. Interest and fees may accumulate on the reverse mortgage balance, potentially increasing the amount owed and reducing the equity remaining in the property over time. Understanding the borrowing limit, costs, repayment conditions, potential effect on home equity and broader retirement or estate implications is important before deciding whether to proceed.