2/4/2020 | Casey Fleming | The reverse mortgage is the most heavily advertised mortgage product today, but all that promotion unfortunately includes very few facts. It is a complex financial product that is not right for everyone, but is a miracle for some and an elegant financial management tool for others. Let’s take a look at what a reverse mortgage really is, what your options are, examine the risks and costs, and look at whether or not it is right for you.
What is a reverse mortgage?
A conventional (or forward) mortgage is what you think of when you think of a mortgage. The bank loans you money, and you make monthly payments on it until it’s paid off.
With a reverse mortgage you still have to pay back the mortgage, but not with monthly payments. (Although you can if you wish.) Instead, you make no payments at all and the interest simply accrues, increasing the amount you owe over time. When you move out of your home or pass away the mortgage becomes due, at which point you have a number of options to pay it back. More on that later.
Reverse Mortgage Options
Advertisements for reverse mortgages commonly only tout one benefit of a reverse mortgage. They might emphasize that you’ll never have to make a payment again, or that you can receive income for the rest of your life. These are true, but confusing, because advertisements are short on details. It turns out that there are several different ways you can set up your reverse mortgage; this is where the confusion lies.
There are three basic ways to receive money from a reverse mortgage:
- Lump Sum: With a lump sum reverse mortgage the lender pays off your existing mortgage, plus any costs, plus any cash you may want up to a pre-determined limit. You receive no other cash after the mortgage is in place. You would use this type of reverse mortgage to eliminate your monthly payments and to generate cash for whatever purpose you want.
- Monthly Payments: With this type of reverse mortgage you receive payments every month for the rest of your life or for a set number of years.
- Line of Credit: This type of reverse mortgage is literally a line of credit. The lender provides a credit line up to a pre-determined amount, and you can draw on it whenever you need cash.
- Finally, you can combine a lump sum (to pay off your existing mortgage and / or generate cash) along with either monthly payments or a line of credit in order to receive the benefits of both.
Speaking of Benefits…
The most obvious benefit for any type of reverse mortgage is the elimination of mortgage payments forever. This can’t be overstated. Many seniors in the United States are struggling to make ends meet in their golden years. Completely eliminating mortgage payments makes a huge difference in monthly cash flow. This helps seniors who would otherwise be forced out of their homes to stay for as long as they want.
A reverse mortgage with monthly payments does more than eliminate monthly payments; it provides even more cash flow. This allows you to have enough cash to pay for necessities and maybe even a few niceties. This can make a huge difference in your quality of life.
A reverse mortgage set up as a line of credit provides any amount of cash when you need it. This is an excellent option for those who have enough monthly cash flow to survive with dignity, but have occasional needs for emergency cash, such as for medical bills or car repair.
A line of credit also has one benefit other types do not. If you do not use all of your line of credit, the unused portion of your credit limit grows each year. This encourages you to use only what you need to, and provides even more cash in future years when you might need it more.
Limitations
Not everyone can get a reverse mortgage. At least one borrower must be at least 62 years old. One spouse can be younger, but the younger a borrower is, the less you can borrow. (Lenders use the youngest borrower’s age to determine the maximum loan amount.)
Your home must have substantial equity. Exactly how much depends on your age and current interest rates, but for most borrowers you should have at least 50% equity in your home.
With most reverse mortgages, the amount of cash you can draw in the first year is limited. Many reverse mortgage customers in the past obtained a reverse mortgage and then used up all of their funds immediately. They were left in about the same position they were in before the got their mortgage. Today, therefore, you can only access about 60% of your total funds in the first year that you have your reverse mortgage. You can access the rest after one year, except for the lump sum option.
A reverse mortgage can only be made on your personal residence, not on second homes or investment properties.
While you do not have to have perfect credit, you do have to make enough income each month to be able to pay for property taxes, insurance, maintenance, and HOA dues if applicable.
Your home has to be reasonably well-maintained. If there is serious deferred maintenance, such as termite damage or a worn-out roof, this will have to be repaired to get a reverse mortgage. You can use the proceeds to make the repairs if there is enough equity in your home.
Risks
The greatest risk of a reverse mortgage comes from the fact that you don’t make payments. It is possible that your loan balance will grow faster than your home’s value increases. Given enough time, then, you could end up owing more on your reverse mortgage than your home is worth. If this happens, you will have no more equity in your home.
The initial loan limit, however, is very conservative. Reverse mortgages are designed so that it is not likely that you will ever be “underwater” on your home. However, it can happen.
Another risk is that most reverse mortgage products carry a variable interest rate. Your interest rate will change over the course of your lifetime, and will probably go up at some point. (It can come down, however, too.)
Costs
The costs of originating a reverse mortgage are not much different than the cost for a conventional mortgage, with one major exception. More on that in a minute. The same people and services are involved in making a reverse mortgage – appraiser, underwriter, escrow officer, title insurance, recording, and some miscellaneous smaller fees. A reverse mortgage is a little more complicated, so fees can be a little higher, but not surprisingly so.
However, most reverse mortgages are insured by The Department of Housing and Urban Development (HUD) through the Federal Housing Administration (FHA). These are known as Home Equity Conversion Mortgages, or HECMs. An FHA insurance policy guarantees the lender that they will be made whole if they ever lose money on your loan (say, because you owe more than your home is worth.) This means that if you are underwater when you no longer want to live in your home neither you, nor your heirs have to make up the difference – it will be paid for by the FHA insurance policy.
You pay for this policy in two ways. First, there is an up-front mortgage insurance premium of 2% of your home’s value, but only up to the limit in your county. This is a little complicated, but talk to your reverse mortgage professional to find out what your maximum would be.
You also pay a monthly premium based on 0.50% (annualized) of your current loan balance.
Some reverse mortgages, however, are not insured by FHA, and those limitations and costs don’t apply. Non-FHA-insured reverse mortgages are known as proprietary reverse mortgages. In general, proprietary reverse mortgages carry a higher interest rate and more limited terms than HECMs, but are less expensive initially.
Is a Reverse Mortgage Right for You?
Most folks think a reverse mortgage is for homeowners who are house rich but cash poor. They certainly benefit those who fit that description, but many others have found them useful, too.
Let’s start with folks who are having trouble making ends meet. Most often a mortgage payment is the largest single monthly expense for seniors. Eliminating that monthly expense can make a huge difference in the quality of a senior’s life. If this description fits you, you should definitely consider getting a reverse mortgage.
For some seniors it’s not the mortgage payment alone, but just cash flow in general. You can’t deny that life is getting more expensive every year. Groceries, medicine, entertainment, are all getting more expensive. If you have always thought your mortgage payment was comfortable but you seem to be very tight every month anyway, it’s time to consider getting a reverse mortgage. Especially if you are starting to deny yourself the things that bring you joy in your golden years – travel, dinners out, gifts for your loved ones – it’s time to call.
You might be sitting on a comfortable investment portfolio and think a reverse mortgage isn’t right for you. But what if it’s a bad time to draw down your assets? Let’s say the market falls and now is a bad time to sell. You still have expenses. Do you sell even when it’s a bad time?
Not if you have a reverse mortgage structured as an equity line. You can use your equity line to fund the cash flow you need now, and then sell your assets off later on when they have gone back up in value, and pay your equity line off. Now a reverse mortgage has become a valuable financial planning tool.
Let’s suppose you are comfortable and have a lot of equity in your home. When you pass away your kids will inherit your estate and be able to dramatically improve their lives. But you won’t be around to enjoy it. Take a lump-sum reverse mortgage now and gift that money to your children so they can use it and you can enjoy watching them use it. A gift for a down payment on a home? Maybe a college degree? How will you feel seeing your children or grandchildren achieving those things while you are still around?
Resources
You are now familiar with the broad-stroke basics of reverse mortgages. As in many things, the devil is in the details. There is not just one way to get a reverse mortgage, and the different products are meant to help different folks with different needs. To truly determine if a reverse mortgage is right for you, you’ll want to speak to a reverse mortgage professional to discuss your circumstances, concerns and goals in detail.
You will find a number of unbiased resources for more information below, or, if you live in California, you may call me at (408) 348-3442. (Sorry, but I am licensed only in California and cannot legally provide assistance in other states.)
Casey Fleming, Author The Loan Guide: How to Get the Best Possible Mortgage (On Amazon)
Mortgage Advisor, C2 FINANCIAL CORPORATION
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HUD’s official site for reverse mortgage information
Kiplinger – What Heirs Need to Know About Reverse Mortgages
Motley Fool – Should You Get a Reverse Mortgage?