Many older Americans have been receiving offers of reverse mortgages in the mail or have seen advertisements on television. This exposure has created much confusion about reverse mortgages among seniors; many believing that they are merely a scam. The truth is that a reverse mortgage can be a good idea, but only for certain individuals. There are several issues that must be addressed when considering a reverse mortgage, and it is imperative that the borrower fully understand all of them.
A reverse mortgage allows the homeowner to live in their home for the rest of their life and receive monthly payments. Because of historically low interest rates and difficult market conditions that have lead to a reduction in retirement assets, some retirees have recently started looking for additional income sources to fill the gaps. A reverse mortgage could help to supplement a retiree’s income, but it could be costly and will deplete the equity in the home.
What is a reverse mortgage? It is a loan that lets the homeowner access the equity in their home without selling it. There are three types of reverse mortgages:
• Single-purpose loans are offered by some state and local government agencies and non-profit organizations. These loans are for one-time major expenses, such as property taxes or a major home repair.
• Home-equity conversion mortgages (HECM), are insured by the Department of Housing and Urban Development (HUD)
• A private loan is backed by the company that develops it (i.e. bank)
The last two are more costly, but can be used for any purpose. The vast majority are HECMs.
A reverse mortgage is different from a regular mortgage or a home equity loan because the borrower does not have to repay the loan until the borrower no longer lives in the home as his primary residence. Since the borrower is not making (or missing) payments, there is no risk of foreclosure. The borrower retains title to the home, and can live in it for the remainder of his life. Repayment of the reverse mortgage is due when the borrower leaves the home, either through the sale of the home or when it is transferred to his estate upon death or if the borrower moves and the home is no longer his primary residence. The proceeds from the sale of the home will pay off the reverse mortgage. The borrower will not be able to pass the house on to heirs unless other funds are available to pay off the reverse mortgage. The remaining proceeds (if any) from the sale of home will be allocated to heirs of the estate. With a reverse mortgage, a borrower can never owe more than the value of the home when it is sold, even if the borrower’s proceeds were more than the home is worth.
Who qualifies for a reverse mortgage? A borrower must be at least 62 years old and live in the home to qualify. Proof of income is not necessary to qualify. Reverse mortgages are offered to borrowers with mortgage liens currently on their home, but the proceeds from the reverse mortgage must be used to pay off the other mortgages. After that, the borrower receives the remaining proceeds.
Is money received in a lump sum or in regular payments? The borrower can receive payments monthly or in a lump sum(s) or even a combination. It is also common to receive a line of credit from which the borrower can draw at any time. The money received is tax-free, and can be used for any purpose (except with the single-purpose loans). The borrower’s age, the interest rates, and the home’s value determine the distribution amount to the borrower. Distributions will be higher for borrowers that are older and have more equity in their homes. Lower interest rates will also increase the borrower’s distribution. Reverse mortgage calculators are available online that can help to estimate the amount a borrower can receive.
What is the cost? Interest is charged on the amount of proceeds received and is compounded over the life of the loan, usually at a variable rate. There can also be a Service Fee Set-Aside (SFSA), which is a sum of money set aside at origination to pay future monthly service fees. It is calculated according to the borrower’s life expectancy. Depending on your age, the SFSA can be several thousand dollars, is not available for you to receive, and you cannot earn interest on it. You are actually charged only $30-$35 per month for the servicing of the loan, but the full SFSA can be set aside at the origination of the loan.
A reverse mortgage can sound like the perfect solution to a senior in need of additional income; however reverse mortgages can be expensive. Similar to when you bought your home, Reverse mortgages typically have origination fees, up-front mortgage insurance premiums, appraisal fees, credit report fees, document preparation fees, recording fees, title insurance, etc. The borrower also continues to pay property taxes and homeowner insurance.
A reverse mortgage is probably not the best choice if one intends on leaving the home in five years or less, or plans on passing the home on to heirs. It might be a better idea to consider other options such as a home equity loan, no-interest loans or grants from your county government, tax deferral programs for individuals having trouble paying property taxes, liquidating a portion of retirement and/or other investment accounts, or even selling the home and moving to a smaller home or a retirement facility. Perhaps the heirs who will eventually inherit the home could preemptively purchase the home instead.
The following is a list of just a few of the organizations and agencies that provide information describing reverse mortgages in greater detail:
AARP www.aarp.org
Federal Housing Administration (FHA) www.hud.org
National Reverse Mortgage Lenders Association (NRMLA) www.reversemortgage.com
Social Security Administration www.ssa.gov