Jan 06, 2015
Reverse mortgages are advertised a lot these days. You might find them featured in TV commercials, touted in radio ads and mentioned online. Usually, these ads depict happy older couples vacationing on cruises or traveling the world with their reverse mortgage funds. However, this is not the intended use of this type of loan. They are designed to be used as a lifeline by retired people who have a built up a lot of equity in their homes and need to supplement their incomes.
Reverse mortgages may be risky, but there are cases where the benefits do outweigh the risks. For some home owners, a reverse mortgage may provide a means for early retirement, a way to afford necessary home improvements or just as a way to liquidate some of the money they have invested in their homes. For others, however, these deals can turn out to be a financial nightmare and can leave their families in the lurch. Learn more about how reverse mortgages work as well as their pros and cons, so that you can decide if this sort of financial arrangement is good for you.
How Reverse Mortgages Work
Reverse mortgages were created as a way to assist seniors facing economic hardship. They are designed for those who have built up a significant amount of equity on their homes but need a way to liquidate that equity in the form of supplemental income.
A reverse mortgage is a loan on which recipients do not need to make monthly payments. Rather, the borrowers receive funds from the lender each month and the loan balance increases accordingly. The loan does not need to be repaid until the borrower (or borrowers) move, sell their house, or pass away.
If you apply for a reverse mortgage, the amount that you will be able to borrow is dependent on your age and how much equity you have built up on your home. The current borrowing limit on federally-backed reverse mortgages is $625,500 or the appraised value of your home, whichever is less. Proprietary lenders can offer funds that exceed that amount.
Different Types of Reverse Mortgages
If you are giving serious consideration to applying for a reverse mortgage, you should be aware that there are three different types available to consumers. These are:
•Single-purpose: Single-purpose reverse mortgages are designed to be used for one specific purpose, such as paying back taxes or making necessary home improvements. They are typically available only to low-to-moderate-income individuals. This type of loan usually comes with the lowest interest rates and associated fees.
•Federally-insured home equity conversion mortgages: Also referred to as HECMs, these are the most common type of reverse mortgage. In fact, the National Reverse Mortgage Lenders association reports that HECMs account for approximately 90 percent of all reverse mortgages. They are backed by the U.S. Department of Housing and Urban Development. You are not required to meet any particular income requirements and you can use the funds for any purpose. However, you must be at least 62 years old, reside in the home you are reverse mortgaging and meet with an independent government-approved housing counselor before you can apply.
•Proprietary: Proprietary reverse mortgages are private loans that are backed solely by the companies that provide them. These loans are sometimes referred to as “jumbo reverse mortgages” because they are designed to meet the needs of those with homes valued at around $750,000 or more. While proprietary reverse mortgages are not subject to the same regulations as federally-backed loans, most lenders offer similar protections to consumers.
The Advantages of Reverse Mortgages
If you are on a fixed income and are strapped for cash, you might benefit from taking out a reverse mortgage. These loans provide a way to get extra income that you otherwise would not have. The funds can be used to pay off your mortgage in order to lower your monthly expenses, to cover healthcare costs, or simply to provide you with extra spending money.
One great advantage of having a reverse mortgage is that the funds you receive are not considered taxable income. As such, this added income will not impact your Social Security or Medicare benefits.
A reverse mortgage might be a good idea if you will be staying in your home for the foreseeable future and:
•You are retired and wish to supplement a fixed income.
•You do not have children or other heirs to whom you wish you leave your estate.
•You have a substantial life insurance policy in place that can be used to repay the reverse mortgage.
If you feel that you are a good candidate for a reverse mortgage, it may be to your benefit to sit down with a financial advisor to discuss this decision in detail.
The Disadvantages of Reverse Mortgages
Reverse mortgages are not a good idea for everyone. If you still owe on your house but are able to easily make your monthly mortgage payments, taking out a reverse mortgage will end up costing you a lot more in the long run. Remember, a reverse mortgage is a loan, and a rather pricey one at that. So if what you are looking for is funding for a project or just some extra cash, you might be better off with a home equity loan.
Costs you can expect with an HECM reverse mortgage might include:
•An origination fee: This can range from $2,000 to a maximum of $6,000, depending on the value of your home.
•A servicing fee: This is to cover administrative tasks such as sending account statements, handling paperwork, and disbursing loan proceeds. Servicing fees typically range from $30 to $35 a month. This fee will be added to your loan balance each month, so your loan may increase much faster than expected.
•Miscellaneous fees: These are fees accrued by third parties prior to closing on the reverse mortgage. They include such things as appraisal fees, title search and insurance fees, recording fees, surveys, inspections and credit checks.
•Mortgage Insurance Premium: Typically referred to as an MIP, this is required FHA mortgage insurance. Most people finance the MIP as part of their loan. If you are borrowing less than 60 percent of the appraised value of your home, you can expect the MIP to be 0.50 percent of the home’s value; if you are borrowing more than 60 percent, however, the MIP rises to 2.50 percent.
Another pitfall common with reverse mortgages occurs if your house loses value over time. You may not be able to make enough money from a sale to fully pay back your loan. Or, if you pass away, the extra owed funds will then come out of your estate and may cause financial problems for those you leave behind. Having a solid life insurance policy can mitigate much of this risk.
Remember, the loan must be paid back as soon as the house is sold or all borrowers are deceased. If others are living in the home when you and your co-borrower pass away, they will have to move out immediately unless they can pay back the loan in full.
A reverse mortgage may be a bad idea if:
•You plan to downsize your home or move to a retirement home within the next 4 or 5 years.
•The fees, interest rates and other financial considerations do not meet your expectations.
•You want to be certain that you can leave the family home to your heirs.
•You have no life insurance policy and may be leaving your estate with a negative balance.
By understanding the potential pitfalls of a reverse mortgage, you are in the best position to decide whether it makes sense for your particular situation.
Reverse Mortgages and Home Expenses
Although your bank will be paying you a mortgage, you are still the home owner. As such, you are still responsible for paying property taxes and keeping your home properly covered by homeowners insurance.
Those who apply for a reverse mortgage should be aware that if they should fail to pay their property taxes, let their homeowners insurance lapse, or fail to properly maintain their home, they can find themselves in default and the lender can foreclose. If your financial circumstances may put you in a position where you will not be able to afford to keep up with these expenses, selling your home and downgrading your living arrangements might be better than taking out a reverse mortgage.
Make Sure Your Home Is Covered No Matter What You Decide
Whether or not you decide to go with a reverse mortgage, remember the importance of keeping your home insurance up-to-date with all the necessary coverage you need. Extra insurance may be necessary, such as if you live in a flood zone or a seismically active area. If your house is damaged and you do not have the proper insurance to repair it, you may find yourself living in a financial nightmare. Be sure to speak with your local Trusted Choice® insurance agent to learn more about your many home coverage options