If you are “house-rich” but “cash poor,” a reverse mortgage might be a way to access some additional cash for your retirement years.
On the other hand, it could be a costly temptation with upfront and ongoing expenses that erode the equity in the home you spent years paying off.
Basically, a reverse mortgage is the opposite of a regular mortgage where you gradually pay off the original principal and accruing interest of the home loan.
With a reverse mortgage, you already own the house (or at least a good amount of equity). The loan amount for a reverse mortgage is not paid down. Whatever interest the lender is charging compounds upward.
Advantages of a Reverse Mortgage
Reverse mortgages have a couple of advantages.
They are FHA guaranteed. That means that at the end of the mortgage whatever price the home is sold for, the value of the home will never be less than the amount owed.
Also, if the lender dies, the estate will not have to pay the lender the difference if the home sale is less than the remaining mortgage amount.
The borrower can receive the loan amount in a variety of ways:
- a line of credit for the maximum amount of the loan
- monthly payments for a specific number of years, or for the life of the loan
- a lump sum amount for cash (applies only to fixed-rate loans)
Note: As of December 14, 2018, the FHA has increased the 2019 limit (or “claim amount”) to $726,525. Assuming a 5.25% mortgage interest rate, a borrower aged 73 with a high-value home could realize an additional $22,000 from an HECM.
Eligibility Requirements/Options for Heirs
Single-family or two-to-four-unit owner-occupied dwellings or townhouses and some condos and manufactured homes can qualify for a reverse mortgage.
The youngest borrower on the home’s title must be at least 62 years of age and meet financial qualifications established by HUD. If the home has an existing mortgage, the borrower must pay off the original mortgage with the proceeds of the HECM.
The borrower’s heirs have the option of repaying the reverse mortgage loan and keep the home in the family, or they can put the home up for sale.
Any home equity, if any, passes to the heirs. Again, the borrower or heirs will never owe more than the loan balance, and only the home is considered an asset when it comes to repayment liability.
Know the Costs Involved
The costs of opening a reverse mortgage can be quite high. For example, the lender can charge a loan origination fee based on the value of the home. Allowed fees range from 2 percent for homes worth $200,000 or less.
For more expensive homes, expect to pay $4,000 plus 1% of the home’s value above $200,000. High value homes will generate origination fees up to $6,000.
Then there is the upfront cost of the initial mortgage insurance premium. The premium is based on the value of the home. If the borrower does stays below the 60 percent limit in accessing the loan principle during the first year, the initial mortgage insurance premium will be $500 for every $100,000 of the home’s value.
Note: The mortgage insurance premium is how the FHA guarantees the value of the property. Even if the lender goes out of business, the FHA will protect both the borrower and lender from loan default.
Ongoing mortgage insurance premiums are due for the life of the loan. Expect to pay an annual mortgage insurance premium equaling 0.5% of the outstanding mortgage balance. Expect to pay a monthly loan servicing fee of up to $30.
So far with loan origination costs and mortgage insurance, the reverse mortgage borrower who owns a home worth about $350,000 is facing over $7,000 in expenses. There are more.
Anticipate a HECM counseling fee for around $125. HUD requires that counseling to make mandatory counseling so that borrowers are fully aware of the consequences of the process.
Also, consider miscellaneous processing fees. Those closing cost includes fees for loan recording, title insurance, credit checks, etc. As in a regular home mortgage, expect to pay an appraisal and home inspection fees which can add another $500 to the upfront expenses.
Regular Costs of Home Ownership Continue
Continuing costs include your annual mortgage insurance payments over the life of the loan.
There are loan servicing fees as well, which add another $30-$35 a month to your mortgage account. Likewise, borrowers are still liable for property tax and home insurance payments.
Signs that a reverse mortgage is not the best idea:
A reverse mortgage might be just the ticket for a senior who needs more retirement income. Reverse mortgages, however, can be difficult to understand, and their interest and upfront fees can cut into a substantial portion of the home’s equity.
For most older adults, there are better solutions. Consider the following four warning signs that a reverse mortgage may not be the best choice:
1. The borrower wants to leave the home as an inheritance.
A reverse mortgage could add complications for the heirs. The only way someone in the family could inherit a home encumbered by a reverse mortgage is to pay off the reverse mortgage debt.
2. Someone else lives in the home.
If the borrower dies, sells out, or moves, and someone who is not on the mortgage lives in the home, that person no longer has a place to live. They must vacate the home immediately when the lender or heirs sell the home.
3. The borrower has medical bills.
Reverse mortgage payments could be a source to pay off medical bills. However, if the borrower’s health deteriorates and must move to a nursing home, the mortgage becomes due.
4. The borrower is financially strapped.
While the FHA requires proof that the lender can afford to stay in the home, unexpected financial emergencies can put a strain on retirement resources. Home maintenance, insurance, and taxes are relentless expenses could make a reverse mortgage a bad choice.
There are alternatives.
A reverse mortgage is an option for someone with lots of equity in their home, but with not enough money coming in for their retirement.
On the other hand, for someone who needs more income and wants to protect the value of their home, there are other strategies:
- Refinance the existing mortgage to lower the monthly payments and free up cash.
- Get a home-equity loan, which is essentially a second mortgage that leverages the existing equity of the home.
- Sell the home and downsize to something more affordable.
- Use the proceeds of the home sale to buy a less expensive place to live with lower maintenance and utility expenses.
- Consider renting and be free of major home-ownership costs like property taxes, insurance and repairs.
Finally, another creative alternative to a reverse mortgage is to sell the home to the heirs. This approach could be a sale-leaseback arrangement. The owner sells the house to his or her children and then rents it from them with the cash from the sale.
This alternative avoids the expenses of an equity-wrecking reverse mortgage. Best of all the senior owner can continue to enjoy living in the home.
To a richer life,
— Nilus Mattive
Editor, The Rich Life Roadmap