Reverse mortgages are loans for homeowners age 62 and older with significant home equity. These loans help you access the equity in your home and can provide financial flexibility. However, you should understand the benefits and potential drawbacks of a reverse mortgage before applying for one.
What Is a Reverse Mortgage?
A reverse mortgage converts home equity on a primary residence into cash or a line of credit. Rather than a homeowner making payments to a lender, the lender makes payments to the homeowner with a reverse mortgage. However, the loan must be paid back eventually, typically with the sale of the home.
Homeowners who take out a reverse mortgage loan can stay in their homes and don’t have to make payments on the loan until they permanently leave the home — whether they sell it, move out or pass away.
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Types of Reverse Mortgages
There are three types of reverse mortgages:
— Home Equity Conversion Mortgages. Insured by the Federal Housing Administration.
— Proprietary reverse mortgages. Not FHA-insured and are generally used for high-value homes.
— Single-purpose reverse mortgages. Offered by state and local governments and may only be used for lender-specified purposes, such as home repairs or property taxes.
Some reverse mortgage lenders offer a line of credit. A line of credit reverse mortgage allows borrowers to draw funds as needed without taking a lump sum or monthly payment.
There’s a lot of flexibility in how borrowers can structure the receipt of loan proceeds, says Steve Irwin, president of the National Reverse Mortgage Lenders Association. “They can establish a line of credit to draw on, establish monthly payments for the rest of their life, known as tenure payments, or they can set up term payments for monthly payments for a set period,” he says. “Or, they can do a combination of the monthly payments for a term or tenure plus a line of credit.”
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Reverse Mortgage Eligibility
Homeowners must be at least 62 years old to qualify for most reverse mortgages, which includes the youngest spouse. For example, if you’re 65 but your spouse is 61, you’ll have to wait until they turn 62 to get a reverse mortgage. Some lenders offering proprietary reverse mortgages may consider applicants younger than 62, but this is rare.
The home must be the borrower’s primary residence, and lenders typically require at least 50% equity in the home. Generally, eligible properties include single-family homes, two- to four-unit homes with one unit occupied by the homeowner and approved condominiums or manufactured homes. Before approval, lenders conduct a financial assessment to determine whether a borrower can meet the loan obligations, including maintaining the home and paying for homeowner’s insurance and property taxes.
FHA loan borrowers must go through specific counseling before taking out a reverse mortgage. This counseling helps borrowers understand the terms, costs and details of the reverse mortgage.
Pros of Reverse Mortgages
— Financial flexibility: A reverse mortgage can give seniors access to home equity without requiring them to sell their home or take out a home equity loan.
— Aging in place: Homeowners can stay in their homes and may use reverse mortgage funds to make accessibility updates that allow them to age in place.
— Asset stability: Reverse mortgages are non-recourse loans. That means if you default on the loan or it can’t be repaid, the lender can’t seize your other assets or those of the estate to satisfy the loan obligation.
— Funds aren’t taxable: Reverse mortgage payments aren’t taxable because they are considered loan proceeds, not income.
Funds can be used flexibly: Except for single-purpose reverse mortgages, funds from reverse mortgages can be used as you see fit. You can pay for health care, home improvements or living expenses. If you get a reverse mortgage line of credit, you can keep it open to use as a safety net if your expenses exceed your cash flow.
“The most typical use is to pay off existing mortgages and other debt to alleviate the burden of having to make monthly payments on those existing loans,” says Irwin. “A reverse mortgage can provide supplementary cash flows or create a standby cash reserve to potentially cover health care costs, major purchases, lifestyle enhancements, in-home care or in-home modifications so those borrowers can effectively age in place.”
[Read: How to Apply for Social Security.]
Cons of Reverse Mortgages
— Loan costs: Though a reverse mortgage pays the borrower initially, it’s still a loan with costs. You may have to pay an origination fee, closing costs, interest, servicing fees and mortgage insurance premiums.
— Loss of home equity: If you use a reverse mortgage to access your home equity, the amount of equity you have in your home will decrease. When the loan becomes due, you or your heirs must pay back the loan. Home sale proceeds can be used to pay the reverse mortgage, but if you want to keep the home, you’ll have to pay back the loan with other funds.
— Foreclosure potential: Lenders require that you maintain the home and continue paying homeowner’s insurance and property taxes. The home could face foreclosure if you don’t meet these obligations.
— Estate planning complexities: Reverse mortgage terms may be difficult to understand, and using one could burden your heirs. Since a reverse mortgage draws equity out of the home, it can lower the inheritance heirs receive. When it’s time to pay back the reverse mortgage, heirs who want to keep the home would need to come up with the funds to repay the debt.
Though reverse mortgages make payments to borrowers, these are still loans, and the balance eventually comes due.
“The balance of a reverse mortgage increases over time as interest and fees accumulate,” says Valerie Saunders, president of the National Association of Mortgage Brokers. “This growing debt can significantly reduce the homeowner’s equity in the property in some cases. As the loan balance increases, the amount of equity left in the home decreases, potentially leaving less for heirs. Heirs may need to sell the home to repay the loan.”
Who Should Consider a Reverse Mortgage?
Reverse mortgages aren’t for everyone, but they can be useful for some seniors. Qualified homeowners with significant equity who want to supplement their retirement income, age in place and have limited liquid assets may want to consider a reverse mortgage. It’s also an option to consider if you don’t have heirs or your heirs are financially independent.
A reverse mortgage might make sense if you:
— Plan to stay in your home as long as possible.
— Don’t have adequate retirement income.
— Have high medical or long-term care expenses.
— Want to delay Social Security benefits.
— Need funds to make home improvements or accessibility modifications.
— Want to pay off your existing mortgage.
Before you apply for a reverse mortgage, make sure you understand the costs and have considered any alternative options. Talk to a financial counselor and estate advisor who can help you navigate the complexities of a reverse mortgage.
A U.S. Department of Housing and Urban Development counselor can offer insight and help you make sense of a reverse mortgage’s terms. Also consider discussing your plans with any family members who may be affected by your decision.
If you decide to proceed with a reverse mortgage, carefully review the loan terms, including the payout options and repayment rules. Also plan to maintain your property and continue paying for homeowners insurance and property taxes.
Alternatives to Reverse Mortgages
If you’re not sure a reverse mortgage is right for you, consider these alternatives:
— Taking out a home equity loan or home equity line of credit.
— Refinancing, such as a cash-out refinance.
— Downsizing into a less costly home to cash out equity.
— Reduce expenses with budgeting and local assistance for seniors.
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When Does a Reverse Mortgage Make Sense? originally appeared on usnews.com
