Reverse mortgages: how do they work?
Reverse mortgages, also called real estate annuities, reverse the financing of a property. Homeowners no longer repay a loan; instead, they receive money. Increase your mortgage to improve your lifestyle? How is this possible?
A reverse mortgage allows homeowners to increase their mortgage to receive an annuity from cashing out on the equity. Specifically:
- The homeowner decides to increase their mortgage debt.
- The amount of this increase is calculated on the basis of the property's value.
- A principal or annuity is paid to the owner by the lender in exchange for this increase.
- In return, the owner must pay the interest on this increase in advance for the duration of the mortgage. Generally, a portion of the annuity is used to pay this interest.
A couple increases their mortgage by CHF 500,000 over a fixed term of 10 years, at an interest rate of 2%. They immediately pay CHF 100,000 in mortgage interest for the entire term of the loan and are paid CHF 400,000 in principal. This will improve their retirement by approximately CHF 3,300 per month over the course of ten years.
Who is eligible for a reverse mortgage?
This process is particularly appropriate for owners of homes that have been well maintained and retain sufficient value, with a low outstanding mortgage. As such, it's most often owners who've reached retirement age who are looking to pursue real estate annuities. They've often made larger mortgage payments than the legal minimum (the first tier of the mortgage must be repaid before retirement). As such, they end up with low outstanding mortgage debt but a limited income that doesn't always allow them to meet all their expenses (higher healthcare costs, unforeseen circumstances, etc.).
What are the advantages and disadvantages of a reverse mortgage?
A reverse mortgage has a few disadvantages:
- A refinanced property
- Risky if the property loses value
- Proper maintenance of the property is required
However, there are several advantages for retirees:
- Better quality of life in retirement
- Money for unforeseen expenses
- The ability to stay in one's home
This last point is very important and is often underestimated. In fact, with the drop in income at retirement, some people no longer have the ability to repay their mortgage. As a reminder, a theoretical interest rate of 5% is used in the affordability calculation and, generally speaking, the sum of mortgage interest, depreciation and maintenance costs cannot exceed one-third of a person's gross income.
Retirees who no longer meet traditional mortgage conditions must then sell their homes. The reverse mortgage offers a solution to this problem.
What are the conditions for qualifying for a reverse mortgage?
Very common in Anglo-Saxon countries, the reverse mortgage is not widely pursued in Switzerland. Only a few lenders offer it, and only under certain conditions which may vary depending on the institution.
- Well-maintained homes that have retained their value
- Homes with a minimum market value of CHF 1 million
- A maximum mortgage of 60% of the property's value
These are generally second tier mortgages that don't require amortization. Learn more about the 1st and 2nd tier
What happens at the end of the reverse mortgage?
When the reverse mortgage expires, the situation must be reconsidered. If the property has increased in value, a new reverse mortgage is an option. A relatively modest increase in value of 1.5% per year translates into a 15% increase in value over a 10-year mortgage term. Therefore, the mortgage can be increased several times and then, for example, be passed on to children, or a sale might be considered. In any case, it's important to anticipate this step.
Reverse mortgages have undeniable advantages in certain situations, but there are many aspects to consider, and they are complex. That's why professional and personalized advice is strongly recommended for understanding whether this is an option you should consider.
Would you like to know if a reverse mortgage is right for you? Our advisors can help you. Make an appointment