It’s hard to live up your golden years when your bank account is a little rusty. Sometimes basic expenses such as home improvements can seem like a financial burden. If you’re in this situation, what are your options?
Well, if you’re a senior over the age of 62 and your financial situation is less than sparkling, then the term “reverse mortgage” has probably entered the conversation. And you have probably wondered whether, in fact, a reverse mortgage is the right financial decision for you and your loved ones.
Here’s a basic guide on what a reverse mortgage is, how to make it work best for you, and what other options are available.
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What is a Reverse Mortgage?
A reverse mortgage is a type of loan that is available to homeowners who are 62-years-old or older. It allows potential borrowers to access a portion of their home’s equity. Once they cash in on the equity, they can supplement Social Security payments and other retirement income. Or they can use a lump sum to pay for medical bills, home improvements or other immediate needs.
This is a unique sort of loan where the cash you receive from the reverse mortgage comes straight from your home’s equity. It sounds like a home equity loan or typical second mortgage. And it is similar. But it has some significant points of difference.
The main difference between a reverse mortgage and a traditional HELOC or second mortgage is that you don’t make payments. In fact, as long as you live in the home as your primary residence, you don’t have to repay the reverse mortgage balance. When you leave the home, though, you owe the full balance.
Typically, homeowners or their estates will just sell the house to pay off the balance of the reverse mortgage. What if the house sells for less than the balance? You just turn over all of the home sale proceeds and walk away. If there’s any money left over, though, it goes to you or your heirs.
These features–not making payments and not owing money if your home value drops–make reverse mortgages an attractive option for retirees with cash flow problems. However, they can be a risky proposition. First, we’ll talk about the three main types of reverse mortgages. Then we’ll cover the pros and cons of this option.
The Three Types of Reverse Mortgages
There are three different options of reverse mortgages. Each has different rules and qualifications for receiving the loan.
1. Single-Purpose Reverse Mortgage
One type of reverse mortgage is a single-purpose reverse mortgage. This option is a bit rare to find and qualify for. Some nonprofits and state and local governments do offer this option.
A single-purpose reverse mortgage is the least expensive option of the three types of reverse mortgages. However, it is also the most restrictive, and can’t be found everywhere. As it says in the name, this type of reverse mortgage can only be used for a single purpose. The lender will spell out the purpose in the loan’s contract. For instance, the loan may stipulate that homeowner only use the money to cover medical bills or home improvements. Typically these types of loans are reserved for low-to-moderate income homeowners.
This type of reverse mortgage can be a good option if your cash flow issues stem primarily from a looming bill, like a big medical bill. They can also be helpful to improve your home so that you can remain in it longer.
2. Federally-Insured Reverse Mortgage
A federally-insured reverse mortgage, also known as a Home Equity Conversion Mortgage (HECMs), is backed by the U.S. Department of Housing and Urban Development (HUD). This is the most common type of reverse mortgage. These loans can be a little more expensive in their upfront costs and fees. This is because the Federal Housing Administration (FHA) insures the loan. And since you’re not repaying anything right away, the premium percentage is higher than standard loans.
You can use an HECM for any reason you choose. And HUD doesn’t have any specific income requirements. Before you apply, though, you’ll have to meet with an independent, government-approved counselor to discuss the loan. This is simply to ensure you’re making a well-informed decision.
HECM loans offer five different payment plans, which include:
- Single disbursement: This is available with fixed-rate loans and doesn’t usually offer as much money as other HECM loans. But it gives you all the money in the loan at once.
- Term: This option gives you a fixed monthly amount for a set number of months.
- Tenure: This gives you fixed monthly income as long as you live in your home.
- Line of Credit: As you might guess, this lets you tap into a line of credit, pay it back down, and then pull money back out as you need it.
- Combination: You can also choose to combine one of the monthly payment options with a line of credit.
The HUD-required counselor you meet with can talk you through all of these options to determine which best fits your needs.
3. Proprietary Reverse Mortgage
The final option is a proprietary reverse mortgage. These are loans provided by private companies. Since each company may have different requirements and rules, it is important to do some research and shopping around in this situation.
Before Applying for a Reverse Mortgage
A reverse mortgage can be a good option for any qualifying homeowner that finds they need some extra income. You’re basically borrowing from yourself, since your home equity is collateral. If you can repay the loan before you leave your home, you’ll get your equity back. But if not, you don’t run the risk of putting yourself or your estate deeply into debt. You or your estate will just pay your home and walk away from any remaining loan balance.
That being said, there are some things you should be aware of when considering a reverse mortgage. In general, lenders charge an origination fee, an insurance premium (for HECMs), and other closing costs. It’s also possible that you will incur servicing fees during the duration of the loan.
Lenders set these fees on proprietary loans. On an HECM, the fees are dictated by law. You will also have to pay interest on the reverse mortgage. This is usually a variable rate, which will fluctuate with market conditions.
FHA-backed reverse mortgages require lenders to collect insurance premiums. Borrowers will pay 2% of the home’s value or the FHA HECM mortgage limit for your area (whichever is lower) upfront, plus a 0.5% annual premium that accrues every month. This is added to the outstanding balance.
This can get expensive, folks! On top of the premium costs, you should expect to pay for an appraisal, credit report, title insurance, legal fees and recording fees – like you would for a standard mortgage.
All of these costs can add up quickly, reducing the amount of money available to you at closing time. Regulations cap lender charges, especially for government-based HECMs. But the fees can still add up quickly. If you want to find numbers more specific to your area, house value, and income, this reverse mortgage calculator will provide you with a good estimate before you go to a lender.
Finally, and most important to note, most reverse mortgages have a “nonrecourse” clause. This prevents the borrower or the estate from owing more to the lender than the value of the home. But a reverse mortgage can take up all or a significant portion of the equity of your home.
This can be bad if you need to move from your home into an assisted living home or nursing home. If you move out of your home, you’ll likely have to sell it to pay off the reverse mortgage. And you may be left without equity to foot the bill for your new living situation.
And even if you are able to stay in your home until you pass away, the reverse mortgage could eat up any equity you’d otherwise leave as an inheritance to your heirs. And if they want to keep the family home, your heirs would have to buy it back from the bank at the market rate.
What Are the Risks?
- According to the AARP, one major risk is foreclosure. You don’t have to make payments on the loan itself, but you still have to pay property taxes and homeowners insurance. If you fail to make these payments, the bank can foreclose on your home. This has always been a problem with reverse mortgages, but it’s become even more so in the past couple of years, according to the AARP article linked above.
- If you are married, make sure you’re both on the mortgage so that the surviving partner can still live in the house in the event the other passes away. If your spouse isn’t on the loan and you pass away or move to a nursing facility, the bank can sell the home out from under your spouse and force them to move out. If you’re both on the reverse mortgage, though, this is not as likely to be a problem.
- The earlier you borrow, the more you’ll pay for your loan. It’s a good idea to wait as long as you can before cashing in on your home’s equity in this way.
- Know your rights–lenders have been known to try to charge relatives interested in keeping the house the balance of the mortgage (including fees) even if it’s more than the house is worth.
How to Reduce the Costs of a Reverse Mortgage
- HECM Saver: The recent (2010) HECM Saver loan, charges only 0.01 percent of a home’s value up front. However, the HECM Saver usually carries a higher interest rate. And you can’t borrow as much as you can with the HECM Standard. The amount you’re allowed to borrow depends on your age, the value of the home, and the interest rate.
- Get the loan later in life: While 62 is the minimum age, you should wait to get a reverse mortgage as long as you can to ensure that you will have money later in life for needs like long-term care. Generally, the more valuable your home, the less you owe on it, and the older you are, preferably in your 70s or 80s, the more money you can extract from your home. You, therefore, make the reverse mortgage work better for you.
- Compare lenders and rates, and keep track of the overall trends. For example, right now interest rates are at a low, and many are choosing a fixed-rate option.
What Are the Alternatives?
Let’s face it–reverse mortgages are pricey. And they may interfere with your family’s inheritance or your own funding for other living arrangements. Here are some options that may provide a similar benefit for less risk
- Cash In: Now is the time to double check your finances. Do you have substantial cash value in a life insurance policy that is no longer needed? Do you have any real estate investments that could be sold or rented? If none of these apply, you can always look into low-income assistance.
- Downsize: Rather than slowly sell your home back to the bank, you could opt to sell your home and move into a more affordable space, such as a condo, or even just a smaller home. You even have the option of renting a portion of your home, which can provide you with both income and company.
- Refinance: As mentioned before, mortgage rates are pretty low right now, so if you currently have a mortgage on your home, would refinancing lower your payments? Chances are it would. Even just an extra $300 a month is still more money in your pocket. Similarly, you could take out cash through a refinance. This gives you a more flexible form of income.
- Home-Equity Loans or Lines of Credit: These loans are less expensive than reverse mortgages and could be the better option if you just need the extra money to, say, repair or improve your home. Of course, you need to have the financial ability to qualify for the loan and make monthly payments. Just be sure that no matter what, thoughts of health and income included, you are able to make the payments.
Bottom line, a reverse mortgage is a high-cost option, and should be considered as the ace up your sleeve, so to speak. You don’t want to use them, as the risk is high, but you will if you have to later in the game.