We have all seen famous actors on television advertising reverse mortgages and talking about how they provide seniors with a stream of income for their old age by tapping into the equity in their homes. It sounds great! But is it? While there may be real benefits for some people, reverse mortgages come with high costs and other serious drawbacks you need to consider. The more you know about reverse mortgages, the better equipped you will be to make a sound financial decision about something as important as your home.
What is a Reverse Mortgage and How does it Work?
A reverse mortgage is a loan, secured by the equity in your house. The more equity you have, the more you can borrow. The lender is basically betting that you will die or sell your house before the value of the home dips below the amount the lender has paid out. There are three types of reverse mortgages.
A single purpose reverse mortgage is the first type. These are offered by state, local and non-profit agencies and are relatively rare.The single purpose reverse mortgage is the least expensive type. The funds can be used only for the single purpose designated by the loan – usually something like home repairs or property taxes.
The home equity conversion mortgage (HECM) is the most common type of reverse mortgage, and it is the type usually advertised on TV. The loan is issued by a private lender, but it is federally insured by the Federal Housing Administration. The HECM puts no limits on how the loan proceeds may be used by the borrower. The homeowner can opt for monthly payments for a specified period of time, a line of credit, or some combination of the two. However, the loan origination fees are much higher than those on the usual home loan, and the interest rate may also be higher. Counseling is required before entering into the loan agreement to educate the borrower about the costs and risks of this type of loan.
A proprietary reverse mortgage is issued by a mortgage lender and is privately insured by the company offering the loan. They are sometimes called “Jumbo” reverse mortgages because the lender offers them only on high priced homes. The most you can borrow with a HECM is $625,500. Someone with a home worth several million dollars may opt for a proprietary reverse mortgage in order to borrow more.
The Good Things about Reverse Mortgages and the Bad
The idea behind a reverse mortgage is a good one. A senior citizen who owns his house free and clear or who has a small remaining balance on his mortgage can use the equity in his house to improve his standard of living. The terms of the loan usually allow the senior to live in the house for the rest of his life, with the house going back to the lender at his death.
However, as a practical matter, the reverse mortgage doesn’t always work to the senior’s benefit. There are serious, potential downsides that need to be considered.
1. Reverse mortgages are expensive. The loan origination fees are much higher than with a traditional mortgage. Reverse mortgages are basically home equity loans where the loan is not based on income or credit score. The lender sees this as additional risk and charges higher loan fees accordingly. The interest rates on the loan are also higher. In some cases, the high fees and interest rates mean the homeowner ends up getting very little money out of the deal. The home equity belongs to the homeowner, but the bank ends up getting a big chunk of it.
2. If the homeowner moves out of the home, the loan repayment clause is triggered. This is an important consideration and one you need to think very carefully about. If you plan to live in your home for many years to come, the reverse mortgage option may make sense. However, if you plan to sell in a few years and move, the reverse mortgage is an impractical option. The high loan costs and interest rates will offset any value you receive from the reverse mortgage.
You also need to consider health issues. While it may be your intention to remain in your home until you die, health problems may short circuit that plan. For instance: You may develop mobility problems that require you to move from your two story home to a place that is all on one level. You may need to move into a retirement community or even a long term care facility. You may need to move to be near family for one reason or another. Be aware! The lender considers you “moved out” if one year elapses without you living in the home. If changes in circumstances or health issues cause you to move out of your home, you will be required to start repaying the reverse mortgage loan. You could find yourself in debt and with few options.
3. If you take out a reverse mortgage, your heirs will not get your house upon your death. If you plan to keep the family home in the family, reverse mortgage is not an option for you.
4. You will be required to maintain the home in good condition, pay homeowners’ insurance and property taxes. You will also be required to purchase an additional insurance policy to protect the lender in case the value of your home falls below the amount owed on the loan. Often the income from a reverse mortgage is not sufficient to pay all these costs and still have a stream of income.
Other Options to Consider
There are other options to reverse mortgage, and you should consider them all before making a commitment to a lender.
1. Downsize. You can sell your home and move into a smaller home, a condominium, or an apartment. This option provides you with cash while it eliminates your responsibility to pay maintenance costs, property taxes, utilities, and homeowners’ insurance on the large family home. It avoids the high costs of the reverse mortgage and the need to insure the lender’s interest. A smaller home usually means smaller costs – lower property taxes and smaller utility bills.
2. Before you decide to tap into your home equity, think about what else you can do to reduce expenses. Are there state or federal programs that may help you lower your utility bills? Do you really need cable TV or that expensive term life insurance policy? Take a close look at your credit card bills and monthly expenses to see exactly where you are spending your money. Make a budget and stick to it.
3. If you are determined to remain in your home, consider a regular home equity loan or line of credit. It is cheaper than a reverse mortgage, but you will need adequate income or assets to qualify.
The important thing to know is this. Reverse mortgages are not a simple solution to all of your money problems. They are not the panacea being advertised on television. While they may be useful for some people in some circumstances, reverse mortgages are fraught with hidden dangers and pitfalls. Be sure you fully understand all the risks and options before you commit to a reverse mortgage. Many of us love our homes and don’t want to think about leaving, but life requires change. Don’t let sentiment and fear of change cloud your judgment. Look at all the possibilities before you decide.
Osterland, Andrew. “Rethinking reverse mortgages: Bad move or bright idea?” CNBC, 2 Apr. 2015, http://www.cnbc.com/2015/04/01/rethinking-reverse-mortgages-bad-move-or-bright-idea.html
FMF. “5 Reasons to Avoid a Reverse Mortgage.” U.S. News & World Report, 12 Dec. 2012, http://money.usnews.com/money/blogs/on-retirement/2012/12/11/5-reasons-to-avoid-a-reverse-mortgage. Accessed 25 Aug. 2016.
“How do I know if a reverse mortgage is a good idea...” Consumer Financial Protection Bureau, http://www.consumerfinance.gov/askcfpb/228/how-do-i-know-that-a-reverse-mortgage-is-a-good-idea-for-me.html
“Types of Reverse Mortgages.” National Reverse Mortgage Lenders Association, www.reversemortgage.org/About/Types-of-Reverse-Mortgages Accessed 25 Aug. 2016.
“What are the Different Types of Reverse Mortgages?” Investopedia, 3 Oct. 2014, www.investopedia.com/ask/answers/100314/what-are-different-types-reverse-mortgages.asp