For seniors wondering how to fund retirement, tapping the wealth you’ve built in your home can seem appealing. But reverse mortgages are complicated and can have big downsides you need to aware of before you commit.
Reverse mortgages allow you to spend down your home’s equity even while you continue to live in it, then pay the money back when you move out, often from the proceeds of a home sale. Last year more than 30,000 Americans borrowed against their homes in this way, according to the National Reverse Mortgage Lenders Association.
The products have been around since the early 1960s. But they took off during the Great Recession, as millions of Boomers hit retirement age just as their stock market wealth seemed to vanish. But that burst of popularity ultimately gave reverse mortgages a mixed reputation, since some of those recession-era borrowers fell victim to high fees and questionable marketing tactics.
In recent years, the government has clamped down on lenders, curbing what many saw as the riskiest loans. As a result, some financial planners think the products are potentially useful, underappreciated tool.
“Used strategically, a reverse mortgage can greatly improve the sustainability of your retirement income,” says Wade Pfau, professor of retirement income at the American College of Financial Services told MONEY in 2016.
With the recent roller-coaster ride the market has been on over the past couple of months, this advice is even more true today.
How Does a Reverse Mortgage Work?
Unlike a typical mortgage, in which you pay the lender a set amount every month until the loan is paid off, the key feature of a reverse mortgage is the bank (or non-bank lender) making payments to the homeowner.
Reverse mortgages are generally structured so the homeowner gets a monthly payment for as long as they live in the house. The loan comes due after the homeowner dies or moves out of the house. At this point, the loan will need to be repaid — which might mean selling the home in order to come up with the funds.
“That is not a weakness of the program, it is by design,” writes Jack Guttentag, a retired economist who maintains the Mortgage Professor website. “The presumption is that the homeowner can make better use of the equity than his heirs.”
Although there are a few different kinds of reverse mortgages, the one you’re most likely to encounter is a federally-insured home equity conversion mortgage, or HECM.
In addition to the “typical” reverse mortgage through which the homeowner receives monthly payments, reverse mortgages can be structured as a line of credit, or you can take a lump sum against the equity in your home.
The latter two might sound similar to conventional home equity loans or lines of credit; the difference is that the borrower retains title to the home and the loan doesn’t have to be repaid until they are no longer living in that home.
Unlike conventional mortgages, though, most reverse mortgages have variable interest rates. Although aggressive Federal Reserve intervention to prop up the economy over the past couple of months makes it likely that rock-bottom interest rates will be with us for some time to come, there is the potential for higher rates in the future.
Who Can Get a Reverse Mortgage?
Reverse mortgages are available to homeowners 62 years old and up. “The older you are, the more benefit you’ll be allowed. The younger borrower will not receive as much loan to value benefit as an older one,” says Ron Kamler, president and CEO of Alliance Reverse Mortgage, a Santa Rosa, Calif.-based broker. As a rule of thumb, a 62-year-old reverse mortgage borrower can expect to get roughly a 45% loan-to-value ratio — a figure that can rise with age as well as the amount of equity you have in your home initially.
And, contrary to what you might expect, you might qualify for a reverse mortgage even if you already have a mortgage, says Bruce McClary, spokesman at the National Foundation for Credit Counseling. “The bottom line is you don’t have to own your home free and clear. There are reverse mortgage options available if you have a conventional mortgage,” he says.
That said, entering into a reverse mortgage — especially if you already have a conventional mortgage — is a decision that should come only after you’ve invested the time researching your options.
Reverse Mortgage Pros and Cons
Reverse mortgages can be complicated, and even people that sell them say they’re not the kind of transaction you should enter into after seeing a couple of commercials (with teeny-tiny print at the bottom of the screen). Since there are many ways a homeowner can access that equity — as a line of credit, monthly payment, lump sum or some combination of those options — there are a host of variables that go into calculating the value, and the cost, of a reverse mortgage. Given the long time trajectory of reverse mortgages, it’s worth keeping in mind that the home is likely to appreciate in value, as well (although this isn’t guaranteed).
McClary says it’s important to make sure you’re working with someone who has your financial best interests in mind — which means someone who’s not trying to sell you a reverse mortgage.
“If you’re facing financial hardship and you’re considering a reverse mortgage to ease that stress, one of the things you need to think about is how long this period of financial hardship is expected to last,” McClary says. “If it’s temporary, you don’t want to get into debt long-term.”
Although new rules introduced in 2013 go a long way towards making sure that reverse mortgages are safer today than they were in the past, they’re still complicated enough that it helps to have an expert in your corner.
“If you want impartial advice as to whether it’s a good idea, you really need to talk to a nonprofit organization that provides counseling and doesn’t have a stake in it,” McClary says. Go to a HUD-approved housing counseling agency and look for agencies specifically approved to provide reverse mortgage counseling, he advises.
Here are some considerations — positive and negative — to keep in mind as you consider if this financial vehicle is the right choice for you.
•The biggest selling point for a reverse mortgage is that as long as you’re living in the home, the loan doesn’t have to be repaid. “They have the choice of either repaying the loan or using the funds without having to repay the loan at all,” McClary says. “Ultimately, the loan gets repaid when the home is sold.” And non-borrowing spouses are protected, as well. They can live in the home as long as it also is their primary residence.
•A reverse mortgage can act as a “safety net” by drawing on the equity you have in your home, rather than tapping higher-priced sources of funds like credit cards.
•You can use reverse mortgage payments to put off drawing Social Security, or to preserve your retirement savings. Especially in a bear market like the current one, a reverse mortgage can give you a supplementary income stream that can keep you from drawing down your retirement nest egg. “Because of the Covid-19 pandemic and the imminent recession, it’s a way for households to increase cash and liquidity,” says Ken Leon, director of equity research at CFRA Research.
•The money you get every month from a reverse mortgage isn’t viewed as income — so you don’t have to pay income tax on it. “A reverse mortgage is simply a loan. It’s not an income qualifier,” Kamler says.
•On the flip side, though, you (or your heirs) don’t get to claim any tax deduction when the loan is paid off, as is the case for a regular mortgage.
•Reverse mortgages also aren’t cheap. These costs generally include an origination fee, appraisal fee and closing costs similar to a regular mortgage. If you’re taking out an HECM, you also will have to pay a Mortgage Insurance Premium — equal to 2% of the home’s appraised value or the FHA lending limit of $765,000, whichever is lower. “That’s the key element that drives the cost of reverse mortgages up,” Kamler says. “It ensures that the borrower will never be in an un-equitable position, it ensures that if the borrower has taken the credit line option, that the funds will be there if the lender goes out of business,” he says.
•Since you still own the home, your other obligations as a homeowner remain. “They’re responsible to pay the taxes and insurance, and to maintain the property,” Kamler says. For homeowners living on a fixed income in an area with rising property taxes, it’s important to budget for the potential of higher taxes, in addition to maintenance issues like the roof, furnace and other big-ticket repairs. “I’ve seen situations where seniors have borrowed using reverse mortgages, taken the proceeds, and then the proceeds ran out, leaving them with no other option to pay for the upkeep of the home,” McClary says. “You really have to plan this out ahead of time before you borrow.”
Reverse Mortgage Pitfalls
In addition to the considerations above, there is also the elephant in the room to consider when it comes to a reverse mortgage: The biggest issue families might have with a reverse mortgage is that it can force a homeowner’s heirs to sell the home when the homeowner dies or needs to move — say, into a nursing home or assisted living facility. While selling the home isn’t a requirement, in reality, it might be the only way to come up with the necessary funds, since the interest and balance due on a reverse mortgage grow over time, instead of shrinking like they would in a conventional mortgage.
“If the intent to stay into the home until they pass on, what might that look like for those in the will?” McClary says, pointing out that if the heirs of a reverse mortgage borrower wants to keep the home in the family after they die, they might not be able to.
“Not everyone has the lump sum to pay off a mortgage. It’s probably going to require they borrow the money to cover a loan — which means getting approved for a mortgage to pay off the reverse mortgage, and that can be costly,” McClary says. “It’s not always as clear-cut as some of the messaging may make it seem.”
Best Reverse Mortgage Lenders
The biggest reverse mortgage lenders aren’t necessarily brand-name banks with branch locations on every corner. Last year, the biggest lenders by volume were American Advisors Group, One Reverse Mortgage and Finance of America Reverse, according to Reverse Mortgage Daily, a trade publication.
As always with mortgages, it pays to shop around, getting quotes from at least three lenders, to make sure you get the best possible deal.
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