A reverse mortgage is the diametric opposite to the mortgage used to purchase a home. With a “forward” mortgage, the home buyer makes payments to the lender, reducing the debt and increasing the equity; with a reverse mortgage, however, the lender makes payments to the borrower, reducing the equity and increasing the debt.

Like any mortgage, a reverse mortgage carries an interest rate. It’s simply part of the cost of doing business with a lender, and certainly no surprise to anyone. What may surprise prospective borrowers, however, is that a reverse mortgage carries a higher level of interest than a forward mortgage, sometimes substantially so.

The reason for this difference is the risk to the lender. With a forward mortgage, as the amount of the debt is decreased, the lender’s risk is being lowered. Should the borrower’s financial situation deteriorate, the lender always has the option of foreclosing on the loan, evicting the borrower, and selling the house to recoup the outstanding amount.

With a reverse mortgage, however, there are no repayments during the life of the loan and therefore no corresponding lowering of the lender’s risk. On the contrary, with the increasing life expectancy among Australia’s senior citizens, these loans can easily remain outstanding for twenty to thirty years—and no banker, however hard-hearted, wants the negative publicity inherent in evicting a pensioner from his or her home.

For this reason, the interest rate for a reverse mortgage is higher than for a forward mortgage. However, the prospective borrower does have several options to consider regarding this interest rate.

All lenders of reverse mortgages are willing to write a loan with a variable rate of interest. Those lenders with a more flexible financial product are also willing to fund a loan with an interest rate that is either fixed or capped, both options either for a certain length of time or over the life of the loan. These lenders include ABN AMRO and Bluestone, which both earned a Five-Star Rating from CANNEX in their October 2007 rating of the reverse mortgage industry, in part for this very flexibility.

Unless the borrower arranges to pay the interest as it becomes due, these charges are added to the amount of the loan and accrue interest themselves (compounding). In this manner, the amount of the loan will roughly double in ten to twelve years, with the actual length of time taken by the process depending in large part upon the actual interest rate charged. Over time and without a no negative equity guarantee in place, it is theoretically possible for the amount of the loan to overwhelm the value of the house.

It is therefore to the borrower’s benefit to ensure the rate of interest is kept as low as possible. Even the difference of half a percent, over the twenty to thirty year life of a reverse mortgage, can mean the saving of tens or even hundreds of thousands of dollars. Shopping around amongst lenders for the most attractive interest rate and options should be part of every prospective borrower’s homework when considering a reverse mortgage.