If you watch TV, you’ve probably seen familiar voices like actor Tom Selleck touting reverse mortgages as an invaluable tool for any retiree. However, every financial product has two sides, so carefully weigh the pros and cons of a reverse mortgage.
What is a reverse mortgage?
A reverse mortgage allows homeowners over the age of 62 to convert real estate capital into cash.
The vast majority of reverse mortgages are insured by the Federal Housing Administration (FHA), which means that if the borrower defaults on the debt, it will be repaid using FHA reserves.
The government refers to reverse mortgages as “HECMs,” or home equity conversion mortgages, and borrowers must pay an upfront insurance premium and an annual premium of 0.5% of the outstanding loan to participate. These premiums are used to fund the FHA’s reserves.
In addition to FHA-guaranteed reverse mortgages, there are two other types:
Proprietary Reverse Mortgages – These are available through private lenders and are not subject to FHA lines of credit.
Single Purpose Reverse Mortgages – These are less common and the money you get from one of these mortgages can only be used for one specific purpose, eg. B. Renovate part of the house or pay property taxes. You can find these options through some state and local governments and nonprofits.
How does a reverse mortgage work?
A reverse mortgage allows you to get money without paying your bills right away.
Consider this math: In a traditional mortgage, if you borrow $100,000 at a fixed rate of 6.71% for 30 years, you would pay $648 per month (principal and interest). If you borrow $100,000 in a reverse mortgage, your required monthly principal and interest payments are zero.
Too good to be true? OK then. You will still owe money. You don’t have to pay back the money until you sell the house, move out, or die. If the latter is the end of your reverse mortgage, the responsibility for paying the debt rests with your spouse or heirs, who may have to sell the home.
In our $100,000 mortgage example, the borrower pays about $648 per month. Of that, about $69 is paid in the first month to reduce the loan balance. The rest of the payment — about $447 — is interest, or what the lender charges you to borrow money — plus an estimated average property tax, which varies by region. The payment plan continues monthly, with more principal payments and less interest over time, until the loan term expires.
Reverse mortgages reverse this process. Instead of paying monthly, you don’t have to pay anything. However, that doesn’t mean the loan is free. The cost of interest is added to the mortgage balance, so the balance increases in the second month. Since the loan balance is now slightly larger and the interest cost is slightly higher, this process continues until the loan is repaid. This repayment is usually made within a year of moving out or death.
Advantages of a reverse mortgage
You can better manage your retirement spending
Many seniors have a significant drop in income after retirement, and monthly repayments may be their biggest expense. A reverse mortgage allows you to supplement your reduced income and keep paying your bills.
You don’t have to move
Rather than leaving your home, a reverse mortgage allows you to grow old in place (and possibly stay close to friends and family). While reverse mortgages have costs, in the long run, getting a reverse mortgage can be cheaper than moving and buying another home or renting in a new location.
You don’t have to pay tax on your income
The income you get from a reverse mortgage isn’t taxed because the IRS considers the money “from the loan.” However, tax regulations can be complex, so be sure to consult a tax professional before taking a reverse mortgage.
You are protected if the balance exceeds the value of your home
As the reverse mortgage balance grows over time, it has the potential to exceed the fair market value of the property. However, the amount of debt to be paid cannot exceed the value of the property, as a reverse mortgage is an example of non-recourse financing. As a result, in this case, the mortgage lender cannot make any claims against your other assets or your heirs.
Your heir has a choice
Reverse mortgages allow borrowers to make early repayments, but usually end when the borrower moves, sells the home, or dies. In the case of probate, the heirs have several options: they can sell the property to pay off the debt and bring the equity above the loan balance; if the property is worth enough, you can keep the home and refinance the balance of the reverse mortgage or, if the debt exceeds the value of the property, the heir can settle the loan by returning the property to the lender. The lender can then file a claim against the insurance company (almost always the FHA) for the unpaid balance.
Disadvantages of reverse mortgages
You have to pay for it
The cost of a reverse mortgage includes lender fees (up to $6,000 in initial fees, depending on the size of your loan), FHA insurance fees, and closing fees. These costs can be added to the loan balance; however, this means the borrower will have more debt and less equity. You’ll also pay a nasty monthly service fee, which can increase by up to $35 if your interest rate is adjusted monthly.
You can’t deduct interest from your taxes until you pay off your loan
Mortgage interest can be deducted from taxes when you pay off your mortgage, but you cannot deduct interest on a reverse mortgage each year. You only receive this benefit when you actually pay off the loan.
You may inadvertently violate other program requirements
In short, a reverse mortgage can cause you to violate your Medicaid and Supplemental Security Income (SSI) program asset limits. It’s complicated, so be sure to consult a geriatric rights attorney or legal clinic before looking for a reverse mortgage program.
Your home may be in foreclosure
Since reverse mortgages do not require monthly principal and interest payments, foreclosure seems impossible. However, this is not the case; foreclosures can occur if you do not comply with property taxes, homeowners insurance, or required HOA fees.
You may not be able to navigate state changes
Reverse mortgages can be complicated, and when your status changes, so can your reverse mortgage options. For example, if you go to a long-term care facility, will you still be considered a resident of your home? If you get married after getting a reverse mortgage, will your spouse have to move out of the property when you die? For more information on these and other issues, you’d be better off talking to a lender, a lawyer specializing in seniors’ rights, or contacting a free legal clinic.
Who is a good candidate for a reverse mortgage?
Is a reverse mortgage really a good idea given the potential complexity and risk of jeopardizing the home? For some homeowners, the answer may be yes:
If you plan to stay at home long-term – since you will be paying additional closing costs through a reverse mortgage, you will need to stay at home long enough to justify the cost. So if you’re 62, have a history of longevity, and believe that your current location is your forever home, a reverse mortgage might make sense. And if you live in a market where property values are rising rapidly, your property may be worth more when you or your heirs pay off the loan.
When you need more money for day-to-day expenses—if you’re struggling to manage retirement expenses, a reverse mortgage can help you have the cash ready to handle those tasks. With the consumer price index reflecting sharp increases in many spending categories like food and gasoline, this may be your immediate need.
Who are the bad candidates for reverse mortgages?
There are many signs that a reverse mortgage is not a good option:
If you’re planning a move — keep in mind that you’ll need a long runway to make it worthwhile to pay all of your closing costs, mortgage insurance premiums, and other expenses. So if you think you may soon be moving to a new location or downsizing to a smaller location, stay away from reverse mortgages.
Needing to move for health reasons – a reverse mortgage requires you to live at home, which means moving to a nursing home or some sort of assisted living may result in you having to pay off your loan. If you are constantly worried about your health, it may be wise to avoid a reverse mortgage.
But if you are struggling to pay the other costs of your home-one of the most important components of a reverse mortgage is your ability to pay your property taxes and homeowner’s insurance. And if you have been struggling to raise money for these basic expenses, increasing your debt should not be on the table.
Here’s How To Get A Reverse Mortgage If It’s Right For You
If you’ve weighed all the pros and cons and think a reverse mortgage is good for you, here’s how to get it:
See if you qualify. To get a reverse mortgage, you must meet some key requirements: You must be at least 62 years old, live in your own home, and have substantial assets (usually at least 50%).
Meet with a HUD-approved financial advisor. Because reverse mortgages are so complex, you’ll need to meet with an expert who can guide you through all of your options.
Compare multiple lenders. Every lender is different and charges different fees. Make sure you check out a range of options to find the lowest entry and settlement costs, as well as the most competitive rates.
Discuss this with your heirs. If you plan to leave your property to anyone in your household, you should discuss your reverse mortgage plan with them. Make sure they understand what it means and what to do when you die.
Bottom Line: Should You Get a Reverse Mortgage?
Reverse mortgages don’t have a perfect reputation due to some scams targeting unsuspecting seniors. Even reputable companies try to trick homeowners into taking out reverse mortgages through dishonest marketing: Consumer Financial Protection Bureau sues and hits American Advisors Group with $1.1 million maximum in late 2021 Penalty for one of the reverse mortgage names. for misleading marketing.
So the simple rule is: be very, very careful about endangering your home.
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