Reverse mortgages are becoming increasingly popular in America, but many are still unsure what exactly they are, and who stands to benefit.
“It’s a buzz word,” said Dean Wegner, a mortgage expert. “‘Hey, I got a reverse mortgage,’ so they’re going with the flow, and I don’t know if everybody actually understands, completely understands a reverse mortgage.”
Older adults who are “house-rich and cash-poor” can benefit from the extra cash flow a reverse mortgage provides.
What is a Reverse Mortgage?
A reverse mortgage allows you to get extra cash each month without having to pay it back immediately or sell your home. In a regular mortgage, you pay your lender each month and your debt decreases while your home’s equity increases.
With a reverse mortgage, the lender pays you each month and you’re not required to pay it back until you die, sell your home or no longer live in the home as your primary residence.
Who Should Consider a Reverse Mortgage?
Simply speaking, a reverse mortgage allows older Americans an opportunity to convert part, or all, of the equity in their homes into cash.
“What happens, as a result, is that people outlive their assets,” said Richard Down, a reverse mortgage specialist at M&T Bank Central New York. “Doctors and medical technology are keeping a lot of people above the daisies … A reverse mortgage is a cash flow solution for senior citizens,” he said.
To qualify for a reverse mortgage, you must be at least 62 years old, live in your home, and own it. The loan is generally tax-free and can be used however you like, to finance a home improvement project, supplement retirement income, pay for health care bills, etc.
Seniors who are choosing reverse mortgages are typically “house-rich and cash-poor,” and the mortgage gives them the extra cash they need after retirement.
How Does it Work?
If you decide to get a reverse mortgage, the cash can be paid to you in a lump sum, as a monthly cash advance, as a “creditline” account that lets you decide how much is paid out, or a combination of the above.
When the debt becomes due — either because you die, sell your home or no longer live in it primarily — you may owe a large amount, so you may receive little or no equity from your home.
However, you can never owe more than the value of your home at the time the loan is repaid. Reverse mortgages are usually “nonrecourse,” meaning that the lender only has rights to your home (not your income, other assets, or income of your heirs).
If the loan needs to be repaid because of death, your heirs can either pay it back using their own funds, by selling your home, or by selling other assets from your estate.
Three Types of Reverse Mortgages
Payment is not due on a reverse mortgage until you sell your home, die or no longer live in it as your primary residence, but be aware that by this time there may not be much (or any) equity left from your home for you or your heirs.
Here is a breakdown of the three basic types of reverse mortgages you’re likely to encounter:
1. Single-purpose reverse mortgages:
Offered by some state and local government agencies and non-profit organization, these mortgages generally have low costs. However, they’re only available in some areas, you generally need a low to moderate income to qualify, and they must be used for a specific purpose, which is specified by the government or non-profit lender. They can be used for things like home repairs or improvements, or property taxes.
2. Federally-insured reverse mortgages:
These mortgages are called Home Equity Conversion Mortgages (HECMs), and are backed by the U. S. Department of Housing and Urban Development (HUD). They have no income qualifications and are widely available, but you must meet with a counselor from an independent government-approved housing counseling agency before applying for the loan.
3. Proprietary reverse mortgages:
Also widely available with no income restrictions, these reverse mortgages are private loans that are backed by the companies that develop them. Though you may be able to get a larger loan at a lower total cost from an HECM, if you own a high-value home, you may be able to get a larger loan advance using a proprietary reverse mortgage.
Some Things to Consider
Before you decide to cash in on your home’s equity, please be aware of these important facts from the Federal Trade Commission:
- Under the HECM program, the borrower is allowed to live in a nursing home or other medical facility for up to one year before the loan must be paid back.
- Your debt will increase over time, as interest is charged on the outstanding balance and added to the amount you owe each month.
- Lenders typically charge origination fees, closing costs and, perhaps, other service fees for a reverse mortgage.
- A reverse mortgage can use up all or some of your home’s equity. This means you’ll have fewer assets left for yourself, or, upon your death, to leave to your heirs (however, you will not owe more than the value of your home when the loan is repaid).
- If you do not maintain homeowner’s insurance or pay your property taxes, the loan may become due.
Why You Should Put Off Getting One and Other Tips
Your home is more than your castle, it’s your ace in the hole.
If you haven’t saved enough for retirement, you figure that you can live on the equity you’ve built up. But in real estate, the easy money has been made. Home prices are falling in some cities and flattening in others. For planning purposes, you should assume a return to a more traditional market, with gains in home values roughly tracing the inflation rate. That means your home won’t provide you with much more purchasing power than you have today. What the experts say to do:
Pay Off Your House
Good advice, but fewer people are taking it. Adjusted for inflation, mortgage debt among people 65 and up nearly tripled from 1989 to 2004, says Zhu Xiao Di of the Joint Center for Housing Studies at Harvard University. Financial planners deplore the trend. “Having to make mortgage payments out of retirement savings, pension or Social Security is a huge hit, financially,” says Morgan Stone of Austin, Texas.
If you’ll feel squeezed, downsize to a smaller place. But be realistic, says Kevin Brosious of Wealth Management in Allentown, Pa. After the cost of selling, moving and fixing up your new home, you’ll have less extra cash than you thought.
Some pre-retirees wonder if it’s worth paying off the mortgage faster if home values are flattening out. Answer: Yes, yes and yes. Your return on investment equals your mortgage rate-maybe 6.5 percent-regardless of where home prices go.
Consider the Rental Option
In general, it’s better to own than rent. That’s what you’ll learn by checking the “rent vs. buy” calculators at Dinkytown.net and Mortgage101.com. But if you’re likely to run out of savings, it’s smarter to sell your house, invest the proceeds and move into an apartment, says planner Ray LeVitre of Midvale, Utah. Having the cash for bills trumps all.
Maybe Not a Second Home
Multiple homes are fine if your future income can easily cover the debt. Otherwise, this is no time to borrow. If you want a retirement home, buy it when the great day comes. Planner Ron Rhoades of Joseph Capital Management in Hernando, Fla., says that for every $100,000 you invest in a home, you reduce your cash flow by $7,000 or more in lost income and annual costs.
Be Reverse-Mortgage Smart
Reverse mortgages let you tap your home for cash without having to sell and move. Typically, a bank will lend you 50 percent or more of its value and never ask for monthly payments. Instead, the loan interest and fees are added to your debt. When you move or die and the house is sold, the bank takes its money out of the proceeds. If the loan has grown to more than the house is worth, the bank gets the house but nothing more.
Financial planners hate reverse mortgages for new retirees. That’s because the costs are huge. Fees alone, not even counting interest, could reach $25,000 and more on federally insured loans, says Ken Scholen, AARP’s reverse-mortgage expert. Lenders have gotten away with these charges because there’s practically no competition. Just one product-the FHA-insured Home Equity Conversion Mortgage (HECM)-accounts for almost all the loans on homes of moderate value. The Financial Freedom Cash Account dominates lending on pricey homes. And just one financial entity backs the HECM market-Fannie Mae, which buys these loans from banks and sets the interest rate.
All that’s about to change. Reverse Mortgage of America, a subsidiary of Seattle Mortgage, will soon roll out a lower-cost loan it calls a Lifestyle Plan. Countrywide Mortgage is planning an entry, too. In a pre-emptive strike, Financial Freedom recently cut its own loan costs. And this week Ginnie Mae, which buys mortgages and resells them to investors, is announcing that it will compete with Fannie Mae-a move that’s expected to lower reverse-mortgage interest rates. By the time you retire, these products will look entirely new. Some tips on how to use them:
- Don’t take a loan now if you can possibly wait. In two or three years, you’ll get better products, more options, and lower fees.
- Never borrow when you first qualify at 62. The younger you are, the smaller the loan and the higher the dollar cost over time. Besides, reverse mortgages should be kept in reserve-something to turn to at a later age if your savings run short.
- Choose a loan from Financial Freedom or Reverse Mortgage of America if you want to borrow for only three or four years. You pay higher interest on these loans (8.87 percent for Cash Account versus 6.4 percent for HECM). But because of their lower upfront costs, they’re cheaper over shorter terms. Look at these loans, too, if you own an expensive home and want to tap it for the highest possible income.
- Choose HECM if you expect to keep the loan for many years. Over time, its lower interest rate makes it more competitive on costs. If you choose a loan with a credit line, HECM will provide you with more long-term borrowing power.
- Get counseling. Two mortgages that appear identical at the start may run up very different costs, and how would you know? AARP (AARP.org/revmort or 800-209-8085) will help you find a free government-approved counselor.
- Beware the hype. Mortgage brokers earn fat fees on these loans. So they’ll urge you to take one now-to finance a cruise, prepay your current mortgage, renovate your house, anything that appeals. But what if you decide to sell and move a few years from now? You’ll have paid huge fees, pointlessly, and slashed your equity
At this time of your life, there’s a simple rule: don’t borrow if you don’t have to! For most of your life, your home has been a financial tool. When you retire, it should be your castle again.
Reporter Associate: Temma Ehrenfeld
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