Is a Reverse Mortgage a Wise Choice in Retirement?
With traditional investments under-performing and costs rising, an elderly individual with significant equity in his or her home may consider a reverse mortgage as an attractive source of retirement income. A reverse mortgage is a special type of home loan that allows a homeowner to convert a portion of the home’s equity into cash, either as a lump sum or as a line of credit that can be drawn upon as needed. However, unlike traditional home equity loans or second mortgages, reverse mortgage borrowers do not have to repay the loan while they are living in the home. The accrued principal and interest only come due when the last surviving homeowner either dies or moves out of the home for longer than 12 months. At that time, the home is sold, the reverse mortgage is paid off, and any remaining equity is paid to the homeowner’s heirs. It is important to note, however, that the upfront fees can be substantial and a reverse mortgage will usually cost more in the long run that a traditional home equity loan. Careful consideration should be given to both options when seeking additional retirement income using the equity in a home.
There are many lenders marketing reverse mortgages today. The FHA reverse mortgage program, known as a Home Equity Conversion Mortgage (HECM) is a popular source for reverse mortgages. To be eligible for a FHA HECM, the homeowner must be at least 62 years of age and own the home outright, or have a low mortgage balance that can be paid off at closing with proceeds from the reverse mortgage. The homeowner must also currently live in the home. A prospective borrower is also required to receive counseling from a HECM counselor prior to obtaining the loan. A borrower can qualify for an HECM even if the home was not originally purchased with an FHA-insured mortgage. Although a reverse mortgage does not require monthly payments, the homeowner is required to pay real estate taxes, utilities, and hazard and flood insurance premiums. Unlike a traditional home equity loan, a reverse mortgage generally has no income or credit score requirements, which can make qualification easier.
The amount that can be borrowed with a reverse mortgage is determined by an FHA formula that considers age, the current interest rate, and the appraised value of the home. The more valuable the home (up to a certain point), the higher the loan amount will be, depending on lending limits. If there is more than one borrower, the age of the youngest borrower is used to determine the loan amount.
Although reverse mortgages may appear attractive, they are not the answer for all seniors. It is important to understand the disadvantages and the costs as compared to other income sources. Some of the disadvantages when compared to traditional home equity loans include higher fees and costs and the depletion of estate assets that can be left to heirs. Reverse mortgages often include higher closing costs and other fees including an application fee. Insurance premiums required to protect the lender can also add significantly to the overall loan costs. While lenders sometimes allow borrowers to roll closing costs into the cost of the loan and these fees may not be paid out of pocket, they will be deferred and must eventually be paid. Rolling the closing fees into the cost of the loan may also reduce the amount of equity available to the borrower.
Reverse mortgages also have an element of inflexibility when compared to home equity loans. Because a reverse mortgage loan becomes payable in full if the borrower permanently moves from the home, seniors who want to move into a smaller home, in with relatives, or into an assisted living facility may be apprehensive because of the reverse mortgage pending.
Finally, the reverse mortgage significantly reduces or may eliminate the profit received at the sale of the home. This reduces the amount of money heirs will receive from the homeowner’s estate. Traditionally, heirs either inherit the home or instead sell the home and take the monetary proceeds. When a reverse mortgage is in place upon the homeowner’s death, however, the lender is the first entity to claim monetary proceeds.
Since reverse mortgages are marketed to seniors, certain protections are in place to protect against fraud. The FHA does not recommend using any service that charges a fee for referring a borrower to an FHA-approved lender. FHA-approved lenders are identified on the HUD website or can be located by contacting a HECM counselor for a listing. Services rendered by HECM counselors are free or at a low cost.