Reverse Mortgage Considerations
If you’re happy with your home but want more money to live on in retirement, a reverse mortgage may be for you. If you’re house rich but cash poor, a reverse mortgage enables you to tap into the equity in your home while you still live in it.
However, if you’re like most older homeowners, you’ve worked so hard for many years to eliminate a mortgage and get your darn home “paid for” that the thought of reversing that process and rebuilding the debt owed on your home is troubling. Reverse mortgages are loan vehicles that few people understand. And most of today’s reverse mortgage borrowers are low-income, single seniors who’ve run out of other money for living expenses.
Thus, it isn’t too surprising that people who don’t fully understand reverse mortgages often have preconceived, mostly negative notions about how they work. Your first reaction may be to say, “I don’t want to be forced out of my home; I could end up owing more than the house is worth.”
Rid yourself of those notions. You won’t be forced out of your home, and you (or your heirs) won’t end up owing more than your house is worth. Federal law requires that reverse mortgages be non-recourse loans, which simply means the home’s value is the only asset that can be tapped to pay the reverse mortgage debt balance. In the rare case when a home’s value does drop below the amount owed on the reverse mortgage, the lender must absorb the loss.
Some reverse mortgages are good, many are mediocre, and some are just plain bad. The best reverse mortgages merit your consideration. A good reverse mortgage enables you to cost-effectively tap your home’s equity and enhance your retirement income. So if you have bills to pay, want to buy some new carpeting, need to paint your home, or simply feel like eating out and traveling more, a good reverse mortgage can be your salvation.
Reverse mortgage basics
So what exactly is a reverse mortgage, and how does it work? Well, as the name suggests, a reverse mortgage reverses the traditional mortgage process. Think back to when you bought your first home. Unless you had generous and affluent relatives, you probably had to scrape together the money for the down payment and seeming never-ending closing costs. And then you were likely saddled with what seemed like a mountain of mortgage debt.
Every month, thereafter, you dutifully mailed to the mortgage lender a check for the monthly mortgage payment. In the early years of your mortgage, a major portion of those monthly mortgage payments went to pay interest on your outstanding loan balance, but a small amount of each of payment went toward lowering the principal, or in other words, reducing the loan balance. (As the years roll by, the loan balance should pay down at a faster and faster rate until, eventually, your mortgage is paid off.)
A reverse mortgage reverses that process. When you take out a reverse mortgage, the mortgage lender typically sends you a monthly check. Imagine that! You can spend the check any way your heart desires. And, because the check represents a loan, the payment to you isn’t taxable.
As the reverse mortgage lender gives you more payments, you accumulate an outstanding loan balance. You typically don’t have to pay back your reverse mortgage loan until the home is sold (and then the loan and the accrued interest is paid back from the sale proceeds) or, with most reverse mortgage programs, when you move out of the property.
Reverse mortgage payment options
The whole point of taking out a reverse mortgage on your home is to receive money that is drawn from the equity you have in your home. How much can you tap? That amount depends mostly on how much your home is worth, how old you are, and the interest and other fees that a given lender charges. The more your home is worth, the older you are, and the lower the interest rate and other fees a lender charges, the more you should realize from a reverse mortgage.
You can decide how you want to receive your reverse mortgage money:
- Monthly: Most people need monthly income to live on. Thus, a commonly selected reverse mortgage payment option is monthly. However, not all monthly payment options are created equal. Some reverse mortgage programs commit to a particular monthly payment for a preset number of years, and other programs make payments as long as you continue living in your home or for life. Not surprisingly, if you select a reverse mortgage program that pays you for the rest of your life, you’re going to receive less monthly, probably a good deal less, than from a program that pays you for a fixed number of years.
- Line of credit: Rather than receiving a monthly check, you can simply create a line of credit from which you draw money by writing a check, whenever you need income. Because interest doesn’t start accumulating on a loan until you actually borrow money, the advantage of a credit line is that you pay for only what you need and use. If you have fluctuating and irregular needs for additional money, a line of credit may be for you. Because you have to take the initiative to draw on a line of credit, some thrifty seniors have a hard time tapping and spending the money. The size of the line of credit is either set at the time you close on your reverse mortgage loan or may increase over time.
- Lump sum: The least beneficial type of reverse mortgage is the lump sum option. When you close on this type of reverse mortgage, you receive a check for the entire amount that you were approved to borrow. Lump sum payouts usually only make sense if you have an immediate need for a substantial amount of cash for some purpose, such as wanting to gift money to family or to make a major purchase.
- Mix and match: Perhaps you need a large chunk of money soon for some purchases you’ve been putting off, but you also want the security of a regular monthly income. You can usually put together combinations of the preceding three programs. Some reverse mortgage lenders even allow you to alter the payment structure as time goes on. Not all reverse mortgage lenders offer all the combinations, so shop around even more if you’re interested in mixing and matching your payment options.
The costs of reverse mortgages
Reverse mortgage lenders, of course, aren’t charities; they make money on reverse mortgages by charging an interest rate on the amount borrowed and by collecting other fees. Although many of the costs of a reverse mortgage are similar to those charged on a traditional mortgage loan, some are unique. On a reverse mortgage, you typically see these types of fees:
- Interest: As with a traditional mortgage, the interest rate on a reverse mortgage can either be fixed or adjustable. Fixed-rate loans offer peace of mind because you know upfront what your loan’s interest rate will be. However, you typically end up paying more interest over the life of the loan for the security of a stable interest rate.
With adjustable-rate reverse mortgages, the overall level of market interest rates determines your loan’s future interest rate. If you get an adjustable-rate mortgage and rates significantly increase, your outstanding loan balance increases faster, thus leaving less equity for the day when your home is finally sold. Odds are better, though, that an adjustable-rate loan will save you on interest costs over the long run because interest rates rarely skyrocket and remain elevated. Because you’re taking on additional risks with an adjustable loan, you’ll probably owe less total interest on your reverse mortgage with more equity remaining for you and your heirs after your house is sold.
Fixed-rate reverse mortgages make the most sense for seniors who anticipate using their loans over a number of years — preferably seven or more. Fixed-rate loans also help you sleep better at night if you’re the type who frets over fluctuating interest rates.
- Upfront fees: Most reverse mortgage lenders charge you fees for processing your application, fees for pulling a copy of your credit report, and other fees for originating your loan.
- Closing costs: Your reverse mortgage lender will want to appraise your home to determine its worth. This appraisal helps determine how much you can borrow on your home. The more your home is worth, the more money a reverse mortgage lender lets you tap from your home’s equity. Other common closing costs include title insurance, local recording fees, and inspections.
- Insurance costs: When a reverse mortgage lender commits to giving you a reverse mortgage, the institution is taking a risk. If you live much longer than the lender expects, and your home’s future value falls far short of the expected worth, the reverse mortgage lender can lose money if the amount of your outstanding loan balance exceeds the value of your home. To reduce the risk, mortgage lenders buy insurance. And guess what? You get to pay for the insurance, either as a yearly fee (sometimes called a risk pooling fee) or as a percentage of your home’s value when you take out your reverse mortgage.
A reverse mortgage insurance premium of up to 2.5 percent of the home’s value is payable at closing. This premium is just 0.5 percent if you take no more than 60 percent of the approved funds. In addition to the upfront insurance charge paid at closing, there is also an annual mortgage insurance premium of 1.25 percent of your reverse mortgage balance. This ongoing premium accumulates and is owed and paid once your loan ends and is paid back.
- A portion of your home’s value or future appreciation: Some reverse mortgages include an additional cost. On some loans, this cost is based on a portion of the appreciation in your home’s value from when your reverse mortgage began. On other loans, this added cost is a portion of the value of your home when your reverse mortgage is ultimately paid off from the sale of your home.
Understanding and shopping for reverse mortgages takes time and patience. Don’t rush the process. A number of nonprofit counseling agencies, supported through government funding, stand ready to assist you with sorting through the reverse mortgage options in your area. At the state level, check with the Department of Aging; at the local level, check with the Area Agency on Aging (call the Eldercare Locator Service at 800-677-1116 or visit its website for the agency nearest you). Pick up a copy of the latest edition of Mortgage Management For Dummies (for its wealth of useful material about all types of mortgages, including reverse mortgages.