If you watch any late-night TV, you have probably noticed the ads for reverse mortgages, promising you a way to access money out of your home to augment your income while in retirement. Sound too good to be true?
Reverse mortgages do exist. However, there are some pros and cons you need to consider if you think you may want to tap the equity in your home with a reverse mortgage.
How do Reverse Mortgages Work?
With a traditional mortgage, you are borrowing money from the bank in order to buy a home. With a reverse mortgage, you are doing the opposite, you are taking a home that you already own and accessing the equity.
Sounds like a home equity loan, right? Well, sort of. Reverse mortgages are only available to borrowers age 62 and over who either own their homes outright or who have a considerable equity stake in the home.
The most popular reverse mortgage is the Home Equity Conversion Mortgage or HECM, which in insured by FHA. This means you must use an FHA-approved lender to seek this type of mortgage.
Why Would a Retiree Want to Take Out More Debt?
It seems counter-intuitive that a retiree, living on a fixed income, would mortgage a home that is already paid for. That seems like the opposite of the goal of retirement, which is to be debt-free.
The unfortunate reality is that many seniors may have significant cash tied up real estate assets. If the retiree does not have other adequate sources of income, through retirement savings and Social Security, it may be difficult for them to pay for catastrophic expenses such as extended medical care or expensive home repairs. Or, even if they do have enough outside assets, tapping into principal to pay for big ticket items could reduce the income stream they are getting each month.
A reverse mortgage provides a solution to help them manage expenses using the equity in their homes.
Who is Eligible?
As previously mentioned, reverse mortgages are only available to borrowers who are aged 62 or older (in a spousal situation, at least one spouse must be 62). In addition, there are other criteria for eligibility:
- You must own the home, or have no more than one lien on the property.
- The reverse mortgage must pay off the entire existing mortgage.
- The home must be your primary residence (not a vacation home or investment property).
- It is your responsibility to ensure all property taxes, insurance, and HOA fees are paid.
- The property must be maintained in good condition.
- The property type must be, a) a single-family home, condo or townhouse, b) a multi-unit property with a maximum of four units (with you living in one of them), or c) a manufactured home built after 1976.
Unfortunately, co-ops do not qualify at this time.
How are the Funds Disbursed?
The amount you can borrow depends on the appraised value of the home, the age of the youngest borrower, interest rates, etc. The HECM FHA mortgage limit was $726,525 in 2019, so amount you borrow cannot exceed this limit.
You then have a choice on how you receive your funds. You can get a lump sum payment (which comes with a fixed interest rate). However, if you choose a variable rate, then you have more flexibility in how the funds are disbursed:
- Equal monthly payments (at least on borrower must live in the property as a primary residence)
- Equal monthly payments for a fixed period of time.
- A line of credit that can be accessed as needed.
- A combination of a credit line and monthly payments for as long as you live in the home.
- A combination of a credit line plus equal monthly payments for a fixed period of time.
How is the Money Repaid
This is where the HECM diverges from a standard home equity line. With a traditional home equity line, you have to make monthly payments to pay off the loan. With a reverse mortgage, the retiree does not have to make any payments, which is a benefit for those on a fixed income.
Instead the loan is repaid when the borrower dies, sells the home, or the home is no longer the primary residence. In addition, the borrower will typically never owe more than the home is worth, no matter what happens to property values or how much they receive in payments over time. However, if the homeowner passes away and the amount borrowed is more than the value of the home, the heirs will need to sign a deed-in-lieu to sign the home over the bank to repay the loan (or pay the balance out of other assets in the estate).
If the owner passes away and the house is sold, the mortgage is repaid. If the balance due is less than the sale price on the home, then the difference becomes part of the estate and distributed accordingly.
Obviously, there are some advantages for retirees to be able to access wealth that is built up in their home without having to move but there are also disadvantages.
- No monthly payments
- You can use the funds for whatever you want
- Younger spouses (under age 62) not listed on the mortgage can stay in the home even after the borrower passes away.
- You must have the ability to maintain the home (or pay someone to do it), and keep up with all property-related expenses (property taxes, insurance, HOA fees, etc.)
- You are borrowing against equity, which ultimately reduces what you can pass on to heirs.
- Closing costs and other fees can be high. This reduces the amount you can borrow. Interest rates also are usually higher.
The bottom line is that a reverse mortgage may provide some breathing room for retirees to pay for necessities or to enjoy their retirement. But it’s not a good option if they are still going to struggle with keeping up the home, despite the additional income stream.
There are also repercussions for heirs, in that it can reduce the overall wealth of the estate or force heirs to sign over the house to the bank to settle the loan.
Note: Anyone considering a reverse mortgage must take a HUD-approved counseling class to ensure they fully understand the ins and outs of the product before moving forward.
Visit HUD’s online locator to find and FHA-approved lender or HUD-approved counseling agency. You can also call the Housing Counseling Line at (800) 569-4287.
When it comes to buying or selling your home, we are here to help answer any questions and guide you through a better understanding. Please do not hesitate to contact us at email@example.com or phone us at 202.800.0800.
Tags: Tim Pierson, Northern Virginia, Retirement Planning, Reverse Mortgages, Paying for Retirement, Aging In Place