Before reverse mortgages, pensioners wishing to tap into home equity were presented with two options: either sell the house or get a home equity loan. But since their humble beginnings in the late ’80s, reverse mortgages provided seniors with an additional tool for accessing home equity. The going offer: get cash now, make no monthly payments, and keep your home sweet home. For retirees struggling to make ends meet, a reverse mortgage can provide a much-needed way forward.
A reverse mortgage should be considered only as a last resort. With early retirement planning, such ‘last resort’ options can be easily avoided. Still, reverse mortgages are a far cry from the blinking neon signs offering fast cash in exchange for a car title. At least with a reverse mortgage the borrower gets to keep the title and avoid the ugly monthly payments.
To understand the way a reverse mortgage works, let’s look at its opposite: the traditional home mortgage. Both are mortgages. But with a standard home loan — also known as a forward mortgage — over time the homeowner’s equity rises and the debt falls. A reverse mortgage does just the opposite. With a reverse mortgage, the debt rises and the homeowner’s equity falls.
Unlike a home equity loan or a home equity line of credit which immediately begin monthly collections on the loan, no payment is due on a reverse mortgage until the borrower sells or moves. Borrowers are given a guarantee of lifetime occupancy of the home. But, once the borrower no longer resides at home, the loan must be repaid. Typically, repayment is made from the proceeds from the sale of the home. The good news here is a reverse mortgage will not hold the borrower personally liable nor can they owe more than the market value of the home.
Minimum qualifications require borrowers to be age 62 or over and must either own their home free and clear or have little remaining debt against the house. But, meeting the initial requirements won’t mean the loan is a done deal. Borrowers should be prepared for an extensive interview and educational component before they can sign on the doted line.
Reverse mortgages are becoming ever more popular, in part, due to the customizable distribution options. Seniors may choose to receive one lump sum or monthly advances — either for a limited time or spread out over the course of their lifetime — for as long as they reside in the home. Others may choose to open a line of credit or pick a combination of payment options to suit their cash flow needs.
But, the convenience offered by a reverse mortgage comes with a price tag. Although loan fees can be financed as part of the loan, origination fees can easily cost borrowers in the neighborhood of $12,000- $18,000. Add to that the principal loan amount, interest, and maintenance fees, and the total cost will likely account for a sizeable portion of the home’s total value, if not all of it.
In addition to the costs of maintaining the home, borrowers are also expected to continue home owner’s insurance and property tax payment in addition to paying for routine maintenance on the home.
Currently, reverse mortgages come in three flavors: single-purpose, proprietary, and federally-insured loans. Single-purpose reverse mortgages are very low-cost. But, unlike the other two, they can only be used for one purpose, such as paying property taxes or making house repairs. Proprietary loans are offered through private banks. Although they are more expensive, they lend larger sums. Of the three loans types, the most common is the federally insured Home Equity Conversion Mortgage (HECM).
The actual amount a homeowner can hope to borrow using a reverse mortgage will be significantly less than the market value of the home itself. Although a HECM offers lower interest rates than private lenders, borrowers are subject to regional 203b loan caps ranging from $200,160 to $362,790. Ultimately, the total loan amount will be determined by the value of the home or the regional loan cap (whichever is less), the borrower’s age and the going interest rate.
So how do you know if a reverse mortgage is right for you? AARP advises prospective borrowers to consider three questions: How much would I get?, How much would I pay? and How much would be left at the end of the loan?
Although the lender almost always wins, a reverse mortgage does offer a Band-Aid solution to pending cash flow problems. Some seniors take the loan to eliminate remaining forward mortgage payments still owed on their home. The majority, though, choose a reverse mortgage to pay medical bills. In either case, a reverse mortgage allows the homeowner to live at home while shoring up immediate, and even long-term, cash flow shortfalls.
There are some cases in which you should never take a reverse mortgage. Avoid a reverse mortgage if you are close to the minimum age requirement. Assuming a reverse mortgage early on will provide you little income and will ensure you will have no equity left in your home at the end of the road. If you currently have little equity in your home, a reverse mortgage is also not worth the cost of the loan origination fees. The fees alone will likely eat up what little equity you have. Finally, avoid a reverse mortgage if you expect to move in the near future. The hefty costs of getting the reverse loan will be wasted and the loan will come due as soon as you move out of the home.
Before going forward with your reverse mortgage, consider your options carefully. There are many creative ways of managing cash flow needs without taking a loan against the value of your home.
As always, begin by looking at your budget and cutting unnecessary expenses. Generating additional income may be as simple as renting out a portion of your home. Or, you may consider moving to an area with a lower cost of living. Sell high and buy low. Then, invest the profit from the sale of your home. By doing so, you may be able to create a permanent cash stream without taking on any debt at all!
Finally, investigate community assistance programs. You may find that you qualify for additional social security benefits or for property tax relief.
More information about reverse mortgages can be found by visiting the AARP website at AARP. Of course, the best way to avoid a reverse mortgage is by planning early for retirement. You can also find out more information about traditional mortgages at mortgage-guides.com for those interested.
David John Marotta and Beth Anderson Nedelisky work at Marotta Asset Management, Inc. of Charlottesville which provides fee-only financial planning and asset management.
Image courtesy of *Susie*