What is a Reverse Mortgage and is it right for you?
Reverse mortgages can provide much-needed relief for older homeowners who are struggling financially to cover basic expenses. Effectively, reverse mortgage loans allow you to stay in your home while trading fees, interest and home equity – which is the value of your home minus what you owe on the mortgage – for cash or a line of credit. The most common of these loans are Home Equity Conversion Mortgages, or HECMs, which are federally insured and available to individuals 62 years or older who meet certain requirements. While this all may sound like the perfect solution to your retirement money problems, it’s important to note that these loans are in no way a cure-all. With this option, you may run the risk of default or losing your home if you don’t meet certain ongoing requirements. If your cash shortfall is temporary, there may be other lower-cost and lower-risk alternatives to reverse mortgages.
With that said, let’s review the pros and cons of reverse mortgages in order to determine whether it could be right for you:
Can provide supplemental retirement income.
“There’s a group of people who are house-rich and cash-poor, and that’s the original idea of [who] the reverse mortgage was good for,” says Stephanie Moulton, associate professor of public policy at Ohio State University.
Assuming borrowers can keep up with expenses of owning a home, such as homeowners insurance and property taxes, “the reverse mortgage provides a way for those individuals to liquefy a portion of that equity to cover expenses.” This could be helpful, for instance, if an unexpected job loss or health issues move up retirement plans and you have limited savings. Generally, you have the option to receive the proceeds from a reverse mortgage in monthly payments, a line of credit or a lump sum.
Some financial planners have also used reverse mortgages to diversify portfolios for well-off clients, although this has become a less appealing choice recently due to increased upfront costs.
Can be used to pay off an existing mortgage.
Even if you’re still making payments on a regular mortgage, you might have enough home equity to qualify for a reverse mortgage. In that case, you could use the proceeds to cover those monthly payments and free up money for other expenses.
This move can be appealing to older homeowners whose budgets are strained by monthly bills, and it’s a fairly common use of reverse mortgages. “You may be surprised at the number of seniors who actually obtain a reverse mortgage, pay off that existing mortgage and no longer have a monthly payment,” says Jackie Boies, Senior Director of Housing and Bankruptcy Services at Money Management International, a nonprofit firm that provides reverse mortgage counseling, among other services.
Proceeds are tax-free.
The IRS considers proceeds from a reverse mortgage to be a loan, not income, so you won’t face taxes on it. For older homeowners living on a fixed income, that could come as a relief.
However, there are still plenty of other costs to consider. In addition to drawing on your equity, there are origination fees, mortgage insurance premiums (for HECMs) and interest charges. Until the loan is paid off partially or in full, this interest isn’t tax-deductible.
You could default – and potentially lose your home – if you don’t meet certain requirements.
With a reverse mortgage, you will go into default if you fail to meet the ongoing requirements of the loan. This can lead to eviction and foreclosure, if unresolved, and is very easy to do accidentally if you’re not careful.
There are three main ways you might default:
Living outside the home for most of the year or failing to certify that your home is your principal residence each year.
Not paying property taxes or homeowners insurance.
Not making maintenance repairs to your home required by your lender.
If you don’t think you’ll be able to meet these requirements long-term, you should consider alternatives, such as selling your house and downsizing.
It’s not a good short-term option.
Reverse mortgages are most helpful for long-term financing or income needs. “If you need money in the short-term and you’re going to be able to pay it off, then a reverse mortgage could be quite expensive,” Moulton says. Specifically, she notes the upfront costs for reverse mortgages are higher than other forms of borrowing, in part due to the federal mortgage insurance premiums.
For HECMs, the initial mortgage insurance premium due at closing is now generally 2% of the house’s appraised value. While you can use your loan to cover the cost, that would reduce the amount of money you receive. You could potentially keep more of your home equity and meet your financing needs by borrowing money in a different way. Good short-term financing options include credit cards, personal loans, home equity lines of credit (HELOCs) and home equity loans (HELs).
Heirs may not be able to keep the home.
With HECMs, you need to consider what happens to your home and loved ones when you die. Your heirs will have to pay either the full loan balance or 95% of the home’s appraised value, whichever is less, if they want to keep the house in the family. They can do this by paying out of pocket or getting financing if possible, or they have the option of selling the home or turning it over to the lenders to satisfy the debt. The latter would mean the home no longer stays within the family, but for many these days, that’s not a top concern. “Honestly, we’re not seeing as much of that as we did in years gone by,” Boies says, referring to borrowers who want to pass down family homes to their heirs. “And it doesn’t seem to be much of a hindrance for folks taking out a reverse mortgage.”
IS A REVERSE MORTGAGE WORTH IT?
Assuming you qualify, a reverse mortgage could be a good solution if:
You have a long-term need for additional income or credit, not a one-time expense you could easily pay off, and you’ve already taken advantage of benefits that are available to you such as Medicare and Social Security.
You’re willing to give up equity in your home for income, even if it means your heirs might not be able to keep the home in the long run.
You plan to stay in your home for the rest of your life and can meet the requirements of a reverse mortgage, such as keeping up with property taxes and homeowners insurance.
If you don’t feel that the above fits your needs or capabilities, you should consider other options for your home. This can include selling it and moving to a less-expensive residence or borrowing money in other ways.
Reach out to our team for more information about reverse mortgages and see if it’s the right option for you!