When Henry Winkler extolled the benefits of reverse mortgages seven or eight years ago, maybe that was your cue to head to the kitchen for a bag of chips. However, now that you’re older, you might be taking a second look at this loan marketed toward seniors who want to age in place.
A reverse mortgage allows homeowners age 62 and over to borrow against a portion of their home’s equity to supplement their income while keeping the title to their home. The borrower receives money, either in a lump sum or as they need it, from the lender instead of making payments.
At first glance, that sounds like a sweet deal. However, there’s a lot more to reverse mortgages than a celebrity can tell you in a few minutes. Here’s what you need to know before you cash in your home’s equity to help make ends meet.
Emerging From a Sketchy Past: Reverse Mortgages
A decade ago, the reverse mortgage industry was known for predatory lenders taking advantage of seniors desperate to remain in their homes. Recently, though, the industry has gained some respectability.
“In the past, borrowers didn’t need to qualify for a reverse mortgage, so the product attracted more of a last-resort type of borrower,” says Tim Nelson, a reverse mortgage banker and Certified Reverse Mortgage Professional (CRMP) at VIP Mortgage in Scottsdale, Arizona. “People now have to qualify, so the product has improved. Consequently, we’re getting a much higher quality of borrower.”
A reverse mortgage can be part of a long-term financial strategy, says Nelson. For example, one of Nelson’s clients lost his job at age 64 and didn’t want to claim a substantially lower social security amount by claiming early. “He used money from the reverse mortgage until he reached full Social Security age and then stopped the reverse mortgage income stream and started collecting his full social security income,” says Nelson.
A reverse mortgage could also allow you to avoid taking distributions from your retirement portfolio during a down market. “When the market rebounds, stop the reverse mortgage and resume distributions from the portfolio,” says Nelson. “Taking money from a portfolio in a down market early in the retirement is one of the biggest risks to longevity of a retirement portfolio.”
Nelson, who teaches continuing education classes on reverse mortgages to Certified Financial Planners, says that more than half the financial planners attending his classes are leery of reverse mortgages initially.
“They still think of the reverse mortgage product from eight or ten years ago when it was more of that last resort and too expensive,” says Nelson. “Today, the product is much better and much safer.”
How a Reverse Mortgage Works
Nearly all reverse mortgages are Home Equity Conversion Mortgages (HECM), which are insured by the Federal Housing Administration (FHA) and backed by the U.S. Department of Housing and Urban Development (HUD). This article focuses on the HECM reverse mortgage.
To qualify for a HECM, you must:
- Be at least 62 years old
- Have enough money to pay ongoing property taxes and insurance
- Own your home outright or have a low mortgage balance that can be paid off at closing with proceeds from the reverse loan
- Reside in the home as the primary residence
A decade ago, almost anyone could get a reverse mortgage, which resulted in widespread foreclosures due to unpaid insurance or property taxes. Nowadays, you’re required to meet with a counselor from an independent, government-approved housing counseling agency before you can even apply for a HECM.
The counselor compares costs of different types of reverse mortgages and explains how payment costs, fees, interest and options affect each loan over time. The counselor must also offer possible alternatives such as government and non-profit programs.
“The biggest cost is typically the upfront mortgage insurance premium, which is 2% of the value of the home,” says Nelson. Other costs include the closing costs, loan origination fee and mortgage insurance.
Lenders must also perform a financial assessment on your ability to meet the loan obligations. How much you can borrow is based on your age, the interest rate and your home’s value. Typically, you’re allowed to take up to 60% of your initial principal limit in the first year.
You’ll need to choose one of four ways to receive your money:
- Line of credit: Allows you to draw on loan proceeds at any time in an amount you choose until you use up the line of credit.
- Single disbursement: Only available with a fixed-rate loan and typically offers less money than other HECM options.
- Tenure: Fixed, monthly cash advances for as long as you live in your home.
- Term: Fixed, monthly cash advances for a specific period.
The money you receive is tax-free. You or your estate must pay off the loan when the borrower:
- Allows the home to fall into disrepair
- Fails to pay property taxes, insurance premiums, condo fees or other mandatory obligations and options to bring the loan current are exhausted
- Passes away
- Resides outside the primary residence for more than 12 consecutive months due to illness
- Sells the home or conveys the title to someone else
When it’s time to pay up, the lender can’t just swoop in and take your home, though. HUD regulations allow the borrower or estate at least six months to sell the home to repay the loan. If a loan deficiency exists, the borrower is not held responsible for that amount, which is paid by the FHA and HUD.
Reverse Mortgage Alternatives
Homeowners should take time to consider alternatives before attaching a reverse mortgage to their home, says Mark Gianno, a certified financial planner and president of Gianno & Freda, a tax accounting and financial planning firm in Hyannis, Massachusetts. The reverse mortgage “should be the last resort,” he says.
Like any loan, reverse mortgages come with fees, commissions, closing costs and interest. For example, a $100,000 loan at a 5% interest rate will grow to $105,000 in the first year. Also, unlike a regular mortgage loan, that $5,000 interest isn’t tax-deductible. So, while you’re receiving money to supplement your income, the reverse mortgage loan balance continues to grow.
Another reverse mortgage downside involves future underlying real estate value increases, which result in higher real estate taxes based on increased property values, says Gianno. If the borrower is unable to pay those higher taxes, the loan becomes due.
A reverse mortgage could be part of an overall plan if someone is feeling financially strapped, says Gianno. However, he recommends selling your house instead and using the money as you wish. Or, sell your house to one of your adult children who could allow you to remain in the home.
Your children can even create a loan structure by contributing money through a company like National Family Mortgage, which offers intra-family mortgage loans, including a “private caregiver mortgage loan.” The caregiver loan is a family-funded “reverse-mortgage-like” line of credit that offers features and benefits of a traditional reverse mortgage without the high costs and restrictions.
A Reverse Mortgage: Is It Right for You?
Nelson recommends meeting with a Certified Reverse Mortgage Professional (CRMP) when considering a reverse mortgage. “You should be doing it over the kitchen table and not over the internet or a 1-800 number,” says Nelson. “Invite somebody who can help make the decision, whether it’s your children or a financial planner who can help you decide whether a reverse mortgage is the right product for your situation.”
Another good source for information is the National Reverse Mortgage Lenders Association (NRMLA), which offers a reverse mortgage calculator, a reverse mortgage guide and a reverse mortgage self-evaluation that brings up a detailed estimate of total costs and fees based on your situation and the line of credit desired.
For additional information, see the Federal Trade Commission (FTC) consumer information page about reverse mortgages. To find a low-cost or free reverse mortgage counselor, visit HUD’s search page or call the agency at 1-800-569-4287.
“The reverse mortgage isn’t the right product for everyone, but for many people, incorporating home equity into a retirement strategy can help your retirement portfolio last longer and achieve a better outcome,” says Nelson.
Are you considering including reverse mortgages in your retirement strategy? We’d like to hear more about your retirement plans in the comments below.
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