A reverse mortgage is a type of loan that allows people age 62 or older to convert part of the equity in their homes into cash. The product was designed to help retirees with a limited income to cover their monthly living expenses and health care costs. There’s no restriction, however, on how the cash from the loan is used. Why is it called a “reverse mortgage”? Instead of the home owner making monthly payments to the lender as in a traditional mortgage, the lender makes monthly payments to the home owner. The owner is not required to pay back the loan until the home is sold or vacated. A reverse mortgage increases one’s income without increasing a home owner’s payments and allows them to stay in their home.
The Basics of How a Reverse Mortgage Works
A home is usually a retiree’s largest personal asset and the equity accumulated in the home can be used as collateral for a loan. In this sense, a reverse mortgage is a type of home equity loan. If you’re considering this type of mortgage, the amount you’re eligible for depends most importantly on (1) the value of your home, (2) your age, and (3) current interest rates. You’ll be eligible for more money the more your home is worth and the more equity you’ve accumulated, the older you are, and the lower current interest rates are. The bank makes payments to the borrower based on a percentage of accumulated home equity. The loan needs to be repaid when the borrower dies, sells the home, or permanently moves out.
Which Home Owners Benefit from a Reverse Mortgage?
People who benefit most from this type of mortgage are those who
▪ Don’t plan to move.
▪ Can afford the cost of maintaining their home.
▪ Want to have money available for a “rainy day.”
▪ Need more money to pay bills, unexpected debt, health care costs, or to be more comfortable in their retirement years.
Which Home Owners Would Not Benefit from a Reverse Mortgage?
People in one or more of the following situations would not benefit from this type of mortgage.
▪ Can’t pay for routine costs of maintaining their home even without a monthly mortgage payment.
▪ Will likely go into an assisted living home or a nursing home soon and would thereby not be using their home as their primary residence. Once the home isn’t your primary residence for 12 months, the loan comes due.
▪ Someone who wants the home to stay in the family after their death. While keeping the home in the family could be possible, either the estate or the heir would need the ability to repay the loan without selling the home.
What Are the Pros?
▪ You receive monthly payments from the lender and have more cash for your expenses and needs instead of paying a monthly mortgage.
▪ You can never owe more than the value of your home in a reverse mortgage loan, regardless of how much you borrow. If the balance is less than the value of your home at the time of repayment, you or your heirs keep the difference.
What Are the Cons?
▪ Fees and other closing costs to obtain a reverse mortgage are typically much higher than conventional loans.
▪ The borrower must still maintain the home and pay property taxes and home owners insurance.
▪ If you need to move for any reason for 12 months or longer, such as into an assisted living home, your house is no longer considered your primary residence and the loan comes due. This can be a strain on budget as costs for assisted living or nursing homes are typically quite high. You may need to sell your home to repay the loan, even if you don’t want to.
▪ In most cases, the reverse mortgage decreases the equity in your home over time, which will leave less money to your heirs when the home is sold.
Common Misconceptions
Some folks think the lender takes title to their home with a reverse mortgage. This is not true. You retain your title and the loan is considered a lien against the property.
Some worry that they will be stuck with a large bill when the loan matures. The loan cannot exceed the value of the home. You or your heirs will never owe more than the appraised value of the house at loan maturity.
Some fear that a reverse mortgage means they can be evicted from their home. The lender cannot evict you. However, remember the terms described above about situations when your home is no longer your primary residence for 12 months or longer. The loan will come due and that could mean you’d need to sell your home for the funds to pay back the loan.
Consider Alternatives to a Reverse Mortgage Before Taking the Leap
If you’re interested in taking out a reverse mortgage, you’ll be required to receive mandatory counseling by an independent third party, including an agency approved by the Department of Housing and Urban Development or a national counseling agency such as AARP. These organizations help home owners review alternative options. Since a reverse mortgage usually decreases the equity in your home, it’s often considered a last resort option for people who need the money. Financial advisors often suggest exercising alternative options first, such as liquidating other investments or finding ways to reduce expenses.