Most Americans aren't prepared as they head into retirement. The news isn't all bad, though — with home equity at all-time highs, homeowners have more financial opportunity to bolster their reserves.
If staying in your home for as long as possible and boosting your retirement savings are top of mind, a reverse mortgage is one tool that can help you accomplish your goals. However, this tricky financial product can be a double-edged sword.
While reverse mortgage loans offer the promise of unlocking equity without the burden of monthly mortgage payments, they also come with many complexities and potential risks. In this post, we'll explore the workings of reverse mortgages, the pros and cons, and reverse mortgage alternatives.
How do reverse mortgages work?
Unlike a traditional mortgage, where the borrower makes monthly payments to the lender, with a reverse mortgage, the lender makes payments to the borrower as a lump sum, a line of credit, or regular installments.
Interest accrues on the loan balance over time. The total balance becomes due when the borrower sells the home, moves out permanently, or passes away.
Who’s eligible for a reverse mortgage?
Reverse mortgages have strict requirements. You’ll need to meet the following criteria:
- You can’t owe any federal debts
- Must be at least 62 years or older
- The home must be your primary residence
- Mortgage holders must own 50% equity in the home
- The home can’t be a mobile home or a manufactured home
- You must have the financial means to keep up with repairs, homeowners insurance, and property taxes
How much does a reverse mortgage cost?
Between closing costs and service fees, taking out a reverse mortgage can get expensive.
- Origination fees: These are paid to the lender and can be at most $6,000.
- Real estate closing costs: Such expenses include credit checks, mortgage taxes, recording fees, inspections, surveys, a title search, an appraisal, and other fees. They are typically paid to third parties.
- Interest: Interest will accrue monthly, increasing the balance owed.
In addition to upfront costs, you'll want to factor in these continued expenses:
- Property taxes and homeowners insurance: These are required by the condition of the loan and are recurring yearly costs.
- Initial mortgage insurance premium: Your lender will charge initial and annual mortgage insurance premiums you'll pay to the Federal Housing Administration. This insurance guarantees you'll receive the cash advances you are expecting. These premiums differ from homeowners insurance.
What are the pros and cons of a reverse mortgage?
Consider the following pros and cons when deciding if and when a reverse mortgage is a good idea.
Pros of a reverse mortgage:
- The funds from a reverse mortgage are typically tax-free because the IRS treats it as a loan.
- A reverse mortgage shouldn't affect your Medicare or Social Security benefits.
- You can remain in your primary residence and continue to own your home.
- You can pay off your existing mortgage and not have monthly mortgage payments.
- You can finance fees and closing costs with your reverse mortgage, which lowers your out-of-pocket expenses.
- Your heirs are generally not responsible for repaying any amount exceeding your home's value.
Cons of a reverse mortgage:
- Not everyone will qualify for a reverse mortgage.
- Due to accumulating interest and fees, your loan balance will increase as time passes.
- Reverse mortgage fees are often higher than fees for a traditional mortgage.
- Your lender could still foreclose on your home in some instances if you fail to pay property tax and HOA fees.
- The more home equity you use, the less you leave behind for your heirs.
- Failure to meet the conditions of a reverse mortgage can result in immediate repayment. If you cannot repay the reverse mortgage, you may have to sell your home to pay off what you owe.
What are the 3 types of reverse mortgages?
Home equity conversion mortgages (HECMs)
HECM loans are a specific type of reverse mortgage insured by the Federal Housing Administration (FHA) and regulated by the U.S. Department of Housing and Urban Development (HUD).
Before closing, borrowers must undergo a HUD-approved counseling session, paying roughly $125. Initial mortgage insurance premiums on HECMs are limited to 2% of the property value or the maximum claim amount, whichever is less.
The key advantages of HECMs are:
- Flexibility: You can receive funds as a lump sum, line of credit, fixed monthly payments, or a combination of these options. Additionally, you can use the proceeds for any purpose.
- Government-insured: HECMs are backed by the FHA, meaning you're protected against lender default and have certain consumer protections.
- Non-recourse loan: With a HECM, the borrower (or their heirs) will never owe more than the value of the home at the time the loan is repaid, even if the loan balance exceeds the home's value.
Single-purpose reverse mortgages
Need money to cover a single home-related expense? If so, a single-purpose reverse mortgage may be a good option for you. Not as common as the other types of reverse mortgages, they're primarily offered by state and local government agencies or non-profit organizations.
The key considerations about single-purpose reverse mortgages are:
- Purpose-specific: You can only use proceeds to pay for a specific lender-approved item, such as property taxes or home repairs.
- Lower costs: Since government agencies or non-profit organizations often provide them, single-purpose reverse mortgages tend to have lower upfront costs than HECMs. Additionally, interest rates may be lower.
Proprietary reverse mortgages
If you live in a high-cost-of-living area like San Francisco or New York, you know that your home may be worth far more than the maximum amount allowed by HEMCs. In that case, a proprietary reverse mortgage offered by a private company may be a better option for you. Homeowners with high-value homes can receive a larger loan using this product.
The key considerations for proprietary reverse mortgages include:
- Non-FHA insured: As a result, they don't have the same federal protections and regulations as HECMs.
- Flexible eligibility criteria: Proprietary reverse mortgages may have more lenient eligibility requirements compared to HECMs.
- Fewer restrictions: Since they are not subject to FHA regulations, proprietary reverse mortgages have fewer restrictions on how the loan proceeds can be used.
- Higher costs: Proprietary reverse mortgages typically have higher upfront costs and interest rates compared to HECMs.
Reverse mortgage alternatives
Home equity line of credit: A home equity line of credit (HELOC) works like a reverse mortgage. You can use part of your home's equity to get immediate access to a revolving line of credit — which you can use unrestrictedly. HELOCs generally have a ten-year draw period to pull funds whenever you need. Then, the borrowed funds are converted into a principal-plus-interest loan for a 20-year repayment period.
Home equity loan: A home equity loan, or second mortgage, is another popular reverse mortgage alternative that allows you to access your equity for a lump sum of cash. To repay the loan, you'll have fixed monthly payments over a 5-30 year term. Home equity loans have fewer requirements and conditions to qualify.
Home equity investment (HEI): A home equity investment allows you to tap your equity for a lump sum for a share of your home's future appreciation. There are no monthly payments; instead, you pay at the end of a 30-year term when you decide to sell the home or refinance. HEIs are flexible — there are no income requirements, need for perfect credit, or strict eligibility criteria.
FAQs about reverse mortgages
What are the conditions of a reverse mortgage?
When you sign up for a reverse mortgage, you also agree to particular conditions:
- Homeowners insurance is necessary
- You must stay current on your property taxes
- You must live in the home as your primary residence
- You must stay up to date with home maintenance and repairs
If you cannot meet any of those obligations — such as falling behind on your property taxes or failing to keep your home in good order — your reverse mortgage will immediately become due.
How much can you borrow with a reverse mortgage?
Generally speaking, between 40%-60% of your home's appraised value. However, several other factors can impact the loan amount:
- Borrower's age or the youngest spouse's age when both are on the title
- The appraised value of your home
- The amount of equity you own
- Current interest rates
- The FHA maximum loan amount if using the HECM program — which is currently $970,800
How do reverse mortgages payout?
Common ways you can receive payments from your reverse mortgage include:
- Line of credit: Generally, accessing these funds requires you to submit a written request to the loan servicer.
- Term payments: Term payments permit a fixed monthly payout for a specific time, such as ten years. The amount of money you receive each month during this time will stay the same.
- Payment tenure: You'll receive these fixed monthly payments for as long as you live in your home and it remains your primary residence. The stipends will only end when you and your spouse, if applicable, pass away or leave your home.
Other reverse mortgage payout options are:
- Modified term/line of credit: Allows borrowers a hybrid payout where they get a fixed monthly payment for a specified time and a line of credit.
- Modified tenure/line of credit: This provides fixed monthly payments and a line of credit for however long you remain in your home and use it as your primary residence.
- Single disbursement: You can also request a lump sum payment, meaning you will receive all the proceeds of your reverse mortgage at closing.
How do you pay back a reverse mortgage?
One of the most enticing conditions of a reverse mortgage is that you'll never need to make monthly payments on it — ever. In fact, your reverse mortgage may outlive you, in which case your estate will settle the balance.
Reverse mortgages are paid back in one lump sum, usually from the sale of the home. For most, this happens when they downsize or pass away.
How do reverse mortgages work after death?
The estate, or heirs, will be responsible for paying off the loan. They can repay through the sale of the house, refinancing the reverse mortgage, or opt for a deed in lieu of foreclosure.
Is a reverse mortgage a good idea?
Whether a reverse mortgage is a good idea depends on your unique financial circumstances and goals. It can be a valuable financial tool for some older homeowners looking to access their home equity while continuing to live in their homes. However, it's not without risks and potential drawbacks.
When deciding, it's essential to consider your short and long-term goals. Ultimately, to make an informed decision, seek guidance from a HUD-approved counselor, weigh the pros and cons, and explore all your options.
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