Before deciding Reverse Mortgages are a bad idea, ask yourself if you have all the facts on how they work. This type of mortgage has a lot of benefits, minimal risk, and the potential to relieve the financial burden of many retired homeowners. No, they’re not the right solution for everyone but maybe they’re the right solution for you?
Read this article about how this unique mortgage works and decide for yourself.
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What is a Reverse Mortgage?
A reverse mortgage is a type of mortgage available only to homeowners ages 62+, allowing them to borrow part of their home’s equity without making any mortgage payments. And that’s very different from the normal mortgage. Think of it as a home equity loan, but with only one, big repayment at the end – when you sell, move, or pass away.
There are several reasons for getting a reverse mortgage including supplementing income during retirement. Lots of retired folks own their home free and clear, but don’t have much in retirement savings – a classic case of being “house rich and cash poor.”
A reverse mortgage, however, allows people to access the equity in their home without having to sell it. Or, starting the clock all over again by taking out a new mortgage that requires monthly payments.
Depending on the type of reverse mortgage, extra cash can be used for anything from repairs or renovations to cars and vacations. There are no limits or restrictions by the mortgage lender on how the reverse mortgage proceeds are used.
Although this type of mortgage has many benefits, it also has some pitfalls. Here’s what you need to know in order to make the best decision for you and your home.
What to Know Before You Apply
The National Reverse Mortgage Lenders Association (NRMLA) offers a checklist of considerations to review before approaching a lender. They advise creating a plan to spend the money, as well as a plan to repay the loan. NRMLA also suggests some alternatives to a Reverse Mortgage, like supplementing your income, looking into a traditional home equity loan, or applying for government programs (like Medicaid and Social Security) instead.
If you decide to apply, you’ll want to shop for various lenders and compare their rates and terms. You will also need to be clear about your responsibilities as a borrower. You must have a significant amount of equity in your home. So be prepared for an appraisal. You must have the financial capability to continue to make payments on property taxes, homeowners’ insurance, and homeowners association dues.
Requirements to Qualify for a Reverse Mortgage:
- Be at least 62 years old.
- Be a homeowner.
- Home must be a primary residence throughout the life of the loan.
Three ways to get Reverse Mortgage funds:
- Single lump sum payment
- Equal payments every month
- A line of credit (only use what you need, up to a specified limit)
Factors to Consider Before Applying for a Reverse Mortgage:
According to Bankrate.com’s Reverse Mortgage Guide, the amount you can take out varies based on a number of factors:
- Your age. Older is better.
- Equity in your home. More equity is better.
- Balance due on your mortgage. A lower balance is better.
Types of Reverse Mortgages
There are three types of reverse mortgages.
Home Equity Conversion Mortgage
A home equity conversion mortgage (HECM) is the most common reverse mortgage. The entire mortgage amount can be disbursed all at once or taken in increments. The HECM can be used for any purpose and is federally insured by the United States Department of Housing and Urban Development (HUD).
Single Purpose Reverse Mortgage
A single-purpose reverse mortgage is offered by local government or non-profit organizations. It’s primarily for individuals who earn a low income. The amount the government or organizations lend is generally small. Plus, the money can be used for only one purpose related to the home itself, like property taxes, repairs, or insurance.
Proprietary Reverse Mortgage
A proprietary reverse mortgage is offered and backed by a private company. In many cases, you can use the money for any purpose and you may be able to pull more cash out.
How Much Does a Reverse Mortgage Cost?
A reverse mortgage sounds appealing because it can put cash in your pocket. It allows a person to age in their own home, which can be a priceless experience. It seems like free money, but just like any other loan, there are costs involved. Here are a few costs to keep in mind.
Origination Fees
To process your HECM loan, lenders charge either $2,500 OR 2% of the first $200,000 of your home value, plus 1% of the value amount over $200,000. Fortunately, the fee is capped at $6,000.
Account Maintenance Fees
For the life of the loan, lenders can charge a monthly fee to maintain and monitor your HECM. Monthly service fees cannot exceed $30 for fixed-rate or annually adjusted rate loans. Fees can reach $35 if the rate adjusts monthly.
Interest Charges
A reverse mortgage generally carries a higher interest rate than a regular mortgage. The National Reverse Mortgage Lenders Association (NRMLA) reverse mortgage calculator lists an average HECM fixed rate of 5.060%.
This loan must be paid in full and it is usually paid off by the sale of the home by the borrower or their heirs. If the sales price of the home does not cover the principal and interest due, the lender cannot go after the seller or heirs for the excess.
Why A Reverse Mortgage Might be Good for You
A reverse mortgage doesn’t require you to make monthly payments toward your loan balance. In addition, the money you receive from the loan
can be used for living and healthcare expenses, debt repayment, and other bills.
For retirees with limited retirement savings, a reverse mortgage can help you better enjoy retirement. Plus, if your spouse is not on the loan, he or she can remain in the home after you die.
Lastly, if you find yourself in financial trouble in retirement and are facing foreclosure, you can use a reverse mortgage to pay off the existing mortgage, potentially stopping the foreclosure.
3 Reasons to Avoid a Reverse Mortgage
It’s important to remember, when you take out a reverse mortgage, you must maintain the house in good condition, pay property taxes and homeowners’ insurance. If the loan amount doesn’t isn’t enough to cover these expenses and you don’t have any other financial resources, then this isn’t the right solution to your financial problems.
Remember, with a reverse mortgage, you’re borrowing the equity in your home, which could be a sizable amount of money. The interest on the Reverse Mortgage will be added to the amount you borrow every month. The loan amount grows every month with the addition of this interest due.
This means your heirs will need to pay the total outstanding loan amount after you’re gone if they decide they want to keep the home after you’re gone. More than likely, they’ll need to sell the home in order to repay the loan.
Lastly, double-check the fees and closing costs. For some borrowers, the cost of the loan can be high. You can also inquire if the lender will pay these fees and closing costs from a portion of the Reverse Mortgage.
What Happens If You Change Your Mind
Thankfully, it is possible to reverse a reverse mortgage. Whatever type of loan you go with, you do have time to change your mind. With most reverse mortgages, you have three full business days after closing to cancel the deal for any reason, without penalty. This allows you time to talk with family members once more before making it final. Here’s more information to help you make an informed decision.
The Bottom Line
Reverse mortgages are complicated loan products and should be reviewed carefully. They’re only available to older homeowners, and many of those individuals are on a fixed or limited income that doesn’t keep up with the cost of living.
The Urban Institute has found that there are race and ethnicity differences between the people who choose these products, versus other options like a home equity line of credit (HELOC) or cash-out refinance.
While reverse mortgages can be an ideal way to live out your golden years in dignity, they can also place a higher financial burden on your heirs who may have expected to inherit your real estate. It can be emotional to liquidate a family home when it’s not possible to pay off a sizable loan in full.
For some heirs, reverse mortgages can feel like they’re simply kicking financial burdens to the next generation. Especially when that generation was looking forward to inheriting the home’s equity.
In other families, they are an ideal option because they relieve the immediate financial burden of caring for an elderly family member. In short, these loan products should be discussed in an intergenerational way to confirm they’re the best financial option available. Bring your children and any other relatives who may inherit your home into the conversation.
Together, the family can determine if there are other funds available to ensure you’re financially secure. If a Reverse Mortgage is the only, and best option, the heirs can help make sure the house is valued appropriately. It’s important that your heirs understand the home will not be a part of your estate unless there’s equity remaining at the time the loan must be repaid.