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 62 and older to convert real estate capital into cash for consumption.
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 3.4% for 30 years, your monthly payments (principal and interest) are $443.48. If you borrow $100,000 through a reverse mortgage, you will pay zero monthly principal and interest.
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 onus to pay it lies with your spouse or heirs, who may have to sell the home.
In our $100,000 mortgage example, the borrower pays about $443 per month. Of that, about $160 is paid in the first month to reduce the loan balance. The remainder (about $283) is interest, or the borrowing fee the lender charges you. 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 one 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 looking for a new, more affordable home, a reverse mortgage allows you to retire in place (and possibly stay close to friends and family). Although reverse mortgages have costs, 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 is not taxed because the IRS considers the money to be “gotten 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 increases, it is possible over time to exceed the fair market value of the property. However, the amount of debt to be repaid can never exceed the value of the property, as a reverse mortgage is an example of non-recourse financing. As a result, the mortgage lender cannot make any claims against your other assets or heirs in this situation.
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 Mortgage
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, 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
You may have tax-deducted mortgage interest when you pay off your mortgage, but you can’t deduct interest on a reverse mortgage each year. You only get this benefit when you actually pay off the loan.
You can’t get that much with the fixed price option
HECM is structured so that both floating rate and fixed rate financing options are available. However, if you want fixed-rate financing, you can get less equity than an adjustable-rate reverse mortgage.
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. It’s not like this. If seniors don’t pay property taxes, don’t have home insurance, or don’t pay HOA fees, their home can be subject to foreclosure.
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. Also, if you live in a market where real estate values are rising rapidly (which seems to be the case in many parts of the country at the moment), your property may be worth more if you or your heirs repay 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 prepare the cash for those tasks.
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 to move – remember that you need a long runway to make it worthwhile to pay all the closing costs, mortgage insurance 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.
- If you need 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’re constantly concerned about your health, it might be wise to avoid a reverse mortgage.
- If you’re struggling to pay the other costs of your home – one of the most important components of a reverse mortgage is your ability to pay property taxes and homeowners insurance. If you’ve been struggling to raise cash for these basic expenses, increasing your debt shouldn’t 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 have tried dishonest marketing to deceive homeowners into taking out reverse mortgages: Recently, the Consumer Financial Protection Bureau filed a lawsuit against one of the largest U.S. consulting groups for fraudulent marketing (American Advisors Group) imposed a $1.1 million reverse mortgage penalty.
So, simple rule: be very, very careful about endangering your home.
Still, there are two main reasons seniors might consider their reverse mortgage options today:
- Increased Equity – As home values have risen over the past decade, so has home equity. Between the third quarter of 2020 and the third quarter of 2021, the average U.S. homeowner received more than $56,000 in equity, according to CoreLogic.
- Interest rates are historically low – and while rates are starting to rise and likely to continue in 2022, now is still a good time to borrow money. Interest rates on 30-year loans are currently estimated to remain below 4% next year.
Remember, you have other ways to get cash. Compare a home equity loan with a reverse mortgage to see which one is better for your needs.