When a Reverse Mortgage Does—and Doesn't—Make Sense
Q: My wife and I have no heirs. Our home is worth about $700,000 and nearly paid off. We’re thinking of taking a reverse mortgage at retirement. How does this work, how much could we get, and is it even a good idea? —Larry, Chesapeake Beach, Md.
A: A reverse mortgage is exactly what it sounds like: You are borrowing against the equity in your home, but instead of paying the bank every month, the bank pays you.
Like any home equity loan, a reverse mortgage allows you draw equity out of your house while continuing to live there. Its big advantage over other home equity borrowing is that you don’t have to pay back a dime while you live in the house, but once you sell or are no longer able to occupy the home as your primary residence, the total loan balance, plus interest and fees, must be paid in full.
You can receive the loan as a lump sum, a monthly amount, or a line of credit (essentially, a checkbook you use to spend the funds as needed), or some combination of these. If you still owe money on your mortgage, the new loan can be used to pay off the remaining balance.
The amount you can borrow depends on a variety of factors, including current interest rates, an appraisal of your home, your age (you must be at least 62 to qualify for a reverse mortgage), and your credit rating. The maximum amount allowed by the federal government is $625,000 for 2014. Reverse mortgage interest rates are fairly low, currently around 2% for a variable rate and around 5% for a fixed rate.
As good as that all sounds, there are serious pitfalls to reverse mortgages, says Sandy Jolley, a reverse mortgage suitability and abuse consultant in Los Angeles. The big one is that you’re spending down what’s likely your largest asset. Even though you don’t have heirs to leave the house to, you might need it later to help pay for assisted living or extended home health care. And you cannot take out another home equity loan once you have a reverse mortgage.
Also, reverse mortgage fees can clock in at a whopping 4%—not just of what you borrow but of your maximum loan amount. So in your case, you could be charged $25,000 (4% of $625,000) even if you opened up a reverse mortgage line of credit as an emergency reserve and never drew out any funds. “The fees are rolled into the loan and charged monthly compounded interest until the home is sold or taken by the lender to repay the debt,” Jolley says.
Another major concern with a reverse mortgage is that the lender can call the loan—meaning you have to pay the balance immediately, even if you have to sell your home to do so—should you ever let your homeowners insurance policy expire, get into arrears on your property taxes, fall behind on home maintenance, or move into an assisted living facility for a full year.
Because of these high costs and risks, Jolley suggests using a reverse mortgage only as a last resort. Consult a trusted family member or a financial planner who’s not in the business of selling reverse mortgages about whether you really will need that money in order to live comfortably in retirement. The combination of Social Security and your retirement savings (and the lack of a mortgage payment; congrats on that!) may provide the income you need to live the way you want to live. Save your equity until you really need it.
CORRECTION: An earlier version of this story indicated that at the end of the loan the bank owns the property. The owner retains title to the home.
Read more about reverse mortgages:
When Tapping Your Home Pays
Should You Get a Reverse Mortgage?
The Surprising Threat to Your Financial Security in Retirement