Is a Reverse Mortgage Right For You?
If the word “retirement” resonates with you, you’re not alone. Retirees are enjoying long-awaited travel pursuits, moves to places they’ve been dreaming of and finally being able to check things off their bucket lists. Some of them are paying for these endeavors by taking out a reverse mortgage, which allows certain homeowners to tap into their home equity in their golden years.
If you’ve reached the age of 62, you qualify for a reverse mortgage.
Ask yourself some important questions to determine if this type of mortgage is right for you.
What is a reverse mortgage and how will it affect my kids?
A reverse mortgage is a loan that allows eligible homeowners (i.e., those 62 years and older) to pull equity from their homes, tax-free, in order to supplement retirement funds or offset cost-of-living expenses. Think of it as the flip side of a typical mortgage in which the borrower pays the lender; in this case, the lender pays the borrower, who is not required to pay back the loan as long as he/she is living there.
Typically, the borrower’s heirs use the proceeds from the sale of the home to pay off a reverse mortgage loan once the borrower moves or dies. There are no monthly payments, since the loan doesn’t come due until that time. And because most reverse mortgages are federally regulated, they are non-recourse, meaning neither the borrower nor their heirs are required to pay back more than the sale price of the home.
How does a reverse mortgage work?
The amount you can get (known as the principal limit) depends on several factors, including the current HECM mortgage limit, the home’s market value, current interest rates and your age. The reverse mortgage loan will usually not be for the full value of the home but rather a percentage, and any liens or existing mortgages on the home must be paid first.
You keep the title to the home, though as the loan matures, the home’s equity naturally goes down. As part of estate planning, borrowers and their families should make sure they understand how the proceeds from the sale of the home are to be disbursed upon the borrower’s death.
What are the requirements?
While there are no credit score or income requirements, for a primary homeowner to get a reverse mortgage they must:
- Be 62 or older. If there are co-borrowers, this applies to the youngest borrower.
- Have at least 50% equity in the home or own it outright.
- Have no federal debt delinquency.
- Attend a HUD-approved counseling session with a reverse mortgage counselor to ensure understanding of reverse mortgages and the financial risks.
For your property to be eligible, it must:
- Be the primary residence.
- Be in good condition.
- Be a single-family home, HUD-approved condo, or a manufactured home built after June 1976.
After obtaining a reverse mortgage, you must:
• Keep the home in good condition.
• Remain current on homeowner’s insurance and continue to pay property taxes.
Are there costs I should know about?
It’s always important to know the fees and hidden costs before you get started. Expect to pay the following:
- Upfront mortgage insurance premium of 2% and annual premium of 0.5%
- Origination fees, which vary by lender but are typically 1 – 2% of loan amount
- Servicing fees, which are capped at $30 or $35/month, depending on the type of interest rate
- Other fees, such as the home inspection and appraisal
- Closing costs
The good news is that many of these costs, including interest, can be rolled into the loan, though some people choose to pay out of pocket expenses and not finance them into the loan. For more insights, check out our article on understanding closing costs.
What about interest rates?
With a reverse mortgage, interest is not tax deductible until you pay it, and the deduction is capped at no more than $100,000 of the loan principal. Interest rates for reverse mortgages vary by lender and the type of payout you want.
Your options are:
• Fixed interest rate, which equates to a single, lump-sum payment
• Variable interest rate, which has historically been tied to the LIBOR rate. Note: As of December 31, 2021, LIBOR is no longer being updated and has been replaced with alternative rates such as the Secured Overnight Financing Rate (SOFR). Learn more about SOFR. Since you’re borrowing money over multiple years, the rate adjusts accordingly. Payment options include equal monthly payments, term payments, a line of credit, or a combination of these.
What are the pros and cons of a reverse mortgage?
First, the good news. There are many advantages of reverse mortgages including:
- Access to cash that can help pay for living expenses and other large expenses such as healthcare
- Ability to remain the homeowner and on the title
- Flexible options for receiving and spending the loan funds
- Potential for you or your heirs to receive the difference if the home’s value surpasses the loan balance
- Non-borrowing spouse can remain in the home if the borrower dies
However, also consider some potential disadvantages like:
- Decreasing home equity; increasing debt
- Mortgage insurance premiums, closing costs and other servicing fees that can add up
- If you choose not to make monthly mortgage payments, there’s an increasing principal loan balance
- You must pay property taxes and homeowners insurance or risk the loan coming due.
- If the loan balance surpasses the appraised value of the home, the lender may be able to take ownership of the home.
- There are other ways home ownership could be at risk, especially if the borrower dies and the heirs do not want or are not able to pay off the loan balance.
What should I know about the different types of reverse mortgages?
There are several types of reverse mortgages, but the most common is the Home Equity Conversion Mortgage (HECM), which is federally insured and thus only available through a Federal Housing Agency (FHA) approved lender (not hard to find!). With HECMS, the homeowner may pay more upfront but can typically use the loan proceeds for any purpose, unlike other types of reverse mortgages, and can choose how to receive the funds. The U.S. Department of Housing and Urban Development (HUD) oversees FHA, so all borrowers must receive HUD-approved counseling as part of obtaining a HECM loan.
Can I use a reverse mortgage to refinance?
A reverse mortgage can be used to refinance your existing mortgage, though high upfront costs should be taken into consideration. Also, you must have lived in the home at least 18 months since closing on the original reverse mortgage in order to refinance.
How can I avoid reverse mortgage scams?
Some unscrupulous lenders may use predatory tactics to take advantage of senior citizens and older homeowners, so research who you are borrowing money from. Read our article on common real estate scams to make sure you don’t fall victim to predatory lenders or scammers. Be wary of not only any lender that’s pressuring you to sign a reverse mortgage contract but also contractors suggesting reverse mortgages. Home improvement contractors sometimes pressure older borrowers to obtain a reverse mortgage in order to pay for work around the house.
Watch out for VA loan reverse mortgage scams. Since the VA doesn’t offer reverse mortgages, any advertisement that promises veterans a deal on a reverse mortgage is a scam. And unfortunately, even family members and caregivers can sometimes target the seniors in their life, convincing them to secure a reverse mortgage so they can then take the proceeds themselves. Stay vigilant!
Keep in mind, too, that as with regular mortgages, there is a 3-day right of rescission, so you can cancel during this time period if you choose.
What If I Don’t Qualify?
If for some reason you don’t qualify, but you still need retirement funds, there are alternatives to a reverse mortgage. A home equity loan or home equity line of credit are viable alternatives that allow you to borrow against your home’s equity, either via the total amount upfront or to pull from as needed, respectively. Some people choose to take out a personal loan to access the equity in their home, and there’s always a cash-out refinance, where you replace your existing mortgage with a larger one so you can convert equity to cash. You can even sell your home and downsize, or you can rent part of your home for more income.
Ultimately, if the word “retirement” strikes a chord with you, but you’re unsure how to supplement your income during this time, talk to a lending expert about reverse mortgages and these other options so that you can make an informed decision. Using your home as security for a loan can be helpful for some individuals, but it’s critical to fully understand how it will affect you and your family – both now and in the future.