- Find out the cancellation terms of a loan beforehand.
- Consult a fiduciary to minimize risk.
- Select a reverse mortgage that aligns with your holistic financial plan.
If you watch late night TV, or the cable news channels, you’ve no doubt seen familiar actors (like Robert Wagner, Fred Thompson, Henry Winkler) singing the praises of a reverse mortgage. For someone in retirement, the idea can be a lifesaver: you can live off the equity in your home without having to leave it, or even make payments. And when reverse mortgages were first introduced, they were seen exactly that way: as a last resort option for keeping seniors in their homes as they aged.
But as reverse mortgages have become more common, the people who are taking advantage of them are getting younger. According to a survey conducted by the MetLife Mature Market Institute, 46% of homeowners considering a reverse mortgage are under the age of 70, and 21% are age 62-64. That’s up from 6% of applicants in 1999.
And they’re borrowing for a variety of reasons. According to the same MetLife survey, 67% of potential borrowers are interested in a reverse mortgage in order to pay off debt, 33% to increase income, 27% to enhance their quality of life, and 23% to plan ahead for emergencies.
So what exactly is a reverse mortgage and how does it work?
Reverse Mortgages Defined
A reverse mortgage allows homeowners aged 62 or older to borrow against the equity in their home with the home as collateral. In that sense, a reverse mortgage is like a home equity loan. But a home equity loan requires regular repayments against the amount borrowed; with a reverse mortgage, the borrowed money is repaid in a lump sum, when either the homeowner dies or the home is sold.
How Do Reverse Mortgages Work?
When a reverse mortgage is taken out, the proceeds are first used to pay off any existing loans against the house, including a traditional mortgage. The fees and interest associated with the loan are added to the loan balance.
Depending on the type of reverse mortgage, proceeds from the loan are paid out to the borrower as a lump sum, monthly payments, a line of credit, or a combination of these.
When the house is sold, the lender deducts the amount of the loan balance (which has been growing over time) and if any proceeds are left, they are paid to the borrower, if living, or to the borrower’s heirs.
If the balance of the loan exceeds the value of the house at the time it is sold, the borrower or his or her heirs are not responsible for the difference. Instead the lender’s insurer, which is often the federal government, takes that hit.
3 Flavors Of Reverse Mortgages
Generally speaking there are three types of reverse mortgages:
1. Home Equity Conversion Mortgages (HECM) are insured by the federal government and regulated by the U.S. Department of Housing and Urban Development. They are not a government loan, however, only insured by the government, and the borrower pays an insurance fee to cover this. Most reverse mortgages fall into this category.
2. Single-purpose reverse mortgages are made available by non-profits, as well as some state and local governments, and are among the least expensive type of reverse mortgages. Borrowers, who are usually low income, have to qualify for this type of reverse mortgage. The stipulation is that the proceeds from a single-purpose reverse mortgage are only to be used to pay for one specific thing, such as maintenance of the home or taxes on the property.
3. Proprietary reverse mortgages are private loans offered by companies. They are usually taken against homes with higher values.
Things To Consider If You (Or A Parent Or Older Relative) Are Considering A Reverse Mortgage:
The day may come when you (or your loved one) are considering a reverse mortgage to help bridge the financial gap in retirement. What are some additional things that you need to know?
1. At one time, reverse mortgages were easier to get, and often credit checks were not even done, since no repayments were being made. More recently however, the U.S. Department of Housing and Urban Development has tightened things up, in part to insure that borrowers are able to pay property taxes and insurance on their homes, which they are still responsible for. Homeowners are also responsible for maintaining the home.
2. Not all reverse mortgages are created equal. Origination and service fees, closing costs, and interest rates will be different depending on the kind of reverse mortgage you get and the lender you go through, so shop around. And if you plan to only borrow a small amount or don’t plan to be in your home for very long, there may be other, less expensive ways, to tap your equity.
3. With most reverse mortgages, you have three or more business days to cancel without penalty should you change your mind, and the lender has 20 days to refund any money you paid them to you. Find out the cancellation terms of the particular loan you are considering beforehand, and if you do decide to cancel, do it in writing, send by certified mail, and request a receipt.
4. Complications can arise when only one spouse is on the reverse mortgage and that spouse dies. In certain cases, the surviving spouse has been unable to continue living in the home in that situation. These issues are currently being litigated, and some changes have been made, but it’s an issue worth investigating before you consider taking out a reverse mortgage.
In all cases, do your homework. Among the key findings of a report issued by the Consumer Financial Protection Bureau were that reverse mortgages are difficult to understand, create risks for consumers, and require better counseling than most have today.
Decisions about your home (whether you’re looking at a reverse mortgage, sizing up or down, or selling) are an important part of a holistic financial plan. For advice on how to factor this into your finances, take advantage of a free consultation with one of our advisors.
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