SA Property Finance - Reverse Mortgages
The EAAB receives many queries from both consumers and estate agents regarding the concept of “reverse mortgages” and what this means in practical terms. It is hoped, therefore, that this article will go some way in answering many of these questions. A reverse mortgage is a mortgage loan which is usually made available to senior citizens who own immovable property with a view to releasing the available home equity to the owners at a specified equity percentage for their age.
Home equity, or the market value of a fixed property, represents the difference between the fair market value of the home and the outstanding balance, if any, that is owed to a mortgagee in respect of a mortgage registered over the property. The owner’s equity in a specific immovable property generally increases as regular payments are made in reduction of the capital and interest owing on the mortgage bond and/or as the value of that property appreciates. The owner’s equity in the property will, however, decrease if regular bond repayments are not maintained or as may happen during recessionary times, the fixed property depreciates, or loses rather than gains, value.
Under the conventional mortgage loan situation, the homeowner receiving the advance makes monthly amortised payment to the mortgagee over the term of the loan. After each payment is made the home owner’s equity in the property increases commensurately so that, typically, at the end of the fixed term of the mortgage loan (such as, say, after 25 years) the mortgage will have been paid in full and the property released from the operation of that mortgage bond.
When granting a reverse mortgage loan, however these rules are seemingly “reversed” while yet maintaining the basic principles of a mortgage bond. It is agreed between the mortgagor home owner and the mortgagee lender that the mortgagor’s obligation to repay the loan will be deferred until:
- the home owner dies;
- the home is sold;
- the home owner vacates the property by, for example, moving into a retirement village or an old age home.
The mortgage loan, thus, terminates when the mortgagor dies, sells the mortgaged property or, depending on the mortgage conditions, vacates the property. It is at this stage that the reverse mortgage loan must be repaid to the mortgagee either from the proceeds of the sale of the property or, if the mortgagor has died, by the heirs in the deceased estate. In cases where the proceeds obtained from the sale of the property are insufficient to discharge the loan in full the mortgagee will be obliged to absorb the difference. The mortgagee, thus, must rely entirely on the value of the mortgaged property as security for the repayment of the mortgage loan.
The mortgagor is not obliged to make any payments to the mortgagee during the term of the loan. As all interest accruing on the loan is simply added to the amount due to the mortgagee, the mortgage debt will increase on a monthly basis. The mortgagor, in a reverse mortgage, may elect to receive either a lump sum payment or monthly payments from the mortgagee. Mortgagees will generally require that the reverse mortgage be the only mortgage bond that is registered over the property. While the money advanced may be used for any purpose it will also be required that the mortgagor settle any existing mortgage(s) from the proceeds of the reverse mortgage. It is important, however, that the mortgagor ensure that municipal rates and taxes are promptly paid and that insurance over the mortgaged property is kept current. Failure to do so may result in a default on the reverse mortgage.
The mortgagor may not be evicted from the bonded property by the mortgagee since the mortgagor continues to remain the registered owner of that property. Upon the death of the mortgagor the heirs in the deceased estate are entitled to inherit the bonded property provided that they can settle all amounts then due and owing to the mortgagee. The heirs may, alternatively, decide to sell the property, pay off the amount owing in respect of the reverse mortgage bond and retain the balance of any moneys accruing on the sale.
MYTHS AND MISPERCEPTIONS
There are many myths and misperceptions concerning reverse mortgages and it must be accepted that this product is not suitable for everyone. The best approach, of course, is always to undertake a comprehensive investigation into the product before making any decisions. A major drawback to the use of reverse mortgages is the high upfront costs. It should not be forgotten that reverse mortgages are nothing more than a business transaction in which the mortgagor receives a loan of money in exchange for guaranteeing to the mortgagee that repayment of that loan will eventually be forthcoming. By obtaining an advance on the equity of fixed property the future equity of that property will obviously be constrained. It is always advisable for the prospective mortgagor, thus, to request the reverse mortgage lending institution to indicate, by way of an amortisation table, the anticipated future diminished equity of the property.
This will enable a rational decision to be made as to whether the money to be received from the reverse mortgage is, on a cost-benefit analysis, worth the trade-off of the reduced future equity. Reverse mortgage lenders may often have to wait many years before repayment of the loan is forthcoming and they also accept the risk of the security of the mortgaged property for repayment. It is understandable, therefore, that the interest rate levied on a reverse mortgage loan will inevitably be higher than in the case of an ordinary mortgage bond.
Reverse mortgage lending institutions will not lend a prospective mortgagor the full market value of the property. They are, after all, not buying the home.
The mortgagee will be careful to ensure, when calculating the advance that can be made, that sufficient security remains even after interest has been added to the principal amount of the loan. Reverse mortgage lending institutions will generally be prepared to advance no more than 30% to 80%, and the latter figure only in the most exceptional cases, of the value of the property as a reverse mortgage. The amount approved will be dependent on such risk factors as the mortgagor’s age and the specific programme that has been chosen.
In general residential properties do not equate to unlimited home equity and this position is not changed by a reverse mortgage. A reverse mortgage simply represents a means of tapping into the available home equity. It cannot be over-emphasised, however, that it is always necessary for the prospective reverse mortgage mortgagor to consult with an expert, whether an attorney, accountant or bond originator, before committing to a reverse mortgage relationship.
As can be anticipated, the reverse mortgage qualifications become more lenient with age since, of course, mortality rates increase with age. The fair market value of a property is the amount that a knowledgeable, willing buyer would be prepared to pay for the property to a knowledgeable, willing seller. The amount to be granted under a reverse mortgage is primarily determined by such intrinsic factors as the assessed value of the property, prevailing interest rates, the age of the prospective mortgagor and whether the loan payment is to be taken as a lump sum or in monthly payments. While a lump sum payment will ensure that the cash is provided immediately the interest rate payable on the loans will also be higher.
Courtesy: Agent – The Official Publication of the Estate Agency Affairs Board
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