Shedding light on reverse mortgages

Reverse mortgages are a loan, usually paid back from the sale of your house. Compunding interest...
Reverse mortgages are a loan, usually paid back from the sale of your house. Compunding interest rates need to be taken into account. PHOTO: GETTY IMAGES
Retirement — especially paying for it — is a "should" problem.

We should plan for it, but there is so much to think about.

For today, let’s talk about just one option: reverse mortgages.

You’ve seen the advertisements.

Fit, fun older folks getting money to add life to their years.

How does that work?

First, reverse mortgages are loans. The money isn’t free. These loans need to be paid back in the future.

When you are working, you pay back credit cards, cars loans, and mortgages as you earn.

Reverse mortgages are loans against your house.

When you leave your house, you pay back the loan.

Second, they are kind of like health insurance.

Insurance is a wager.

You and the insurance company are on opposite sides of a bet.

If you stay healthy, the company collects — they make money from your premiums.

If you do not, then you collect.

Insurance companies put a thumb on the scale.

They know more about your risks than you do, and they charge extra. As with casinos, the house usually wins. For reverse mortgages, companies also want to win.

They want their money back with some profit as well.

So, they make sure they do not give you too much money. They look at how much equity you have.

They also look at how old you are — how likely you are to die.

I tried one calculator. For a 60-year-old, it offered a loan of one-fifth the value of the house, for an 80-year-old, it was two-fifths.

By making sure your house is worth a lot more than the loan, companies are protecting themselves.

The other way they protect themselves is with interest.

Reverse mortgages have interest rates of about 10%. That is higher than a standard mortgage and lower than a credit card.

The thing to remember is that interest is compounding.

That means the amount you owe doubles in size in seven or eight years. At some point in the future, the loan may be worth more than the house. So that’s how they work.

With a reverse mortgage, you get some money now and you repay it with interest from the sale of your house. How much you have to repay depends on how long you continue to live in the house. This is not financial advice — I cannot tell you whether they are a good option.

That will depend on you and what happens in your future. Still, it is useful to understand how they work.

— Bill Kaye-Blake is the prinicpal economist at the New Zealand Institue of Economic Research. He is based in Bannockburn.