One of the richest assets many people own is their home. During retirement, this home may be used to provide financial stability. A reverse mortgage is a popular way to provide financial stability to those who are retired and are living on a fixed income.
Tapping into the Value of a Home
A few years ago, there were only two ways to tap into the value of a home:
- Selling the home
- Borrowing against the equity in the home
Selling the home would mean that the residents would have to move somewhere else. Borrowing against the equity in the home would result in monthly payments. Many retirees find that what they assumed would be a comfortable retirement income has been eaten away by inflation, rising health care costs, and unexpected expenses. This results in a less secure retirement.
If these homeowners have substantial equity in their homes, they can turn that equity into cash without having to move to a new home or assume debt that would have to be repaid with a third option: a reverse mortgage.
What is a Reverse Mortgage?
A reverse mortgage is a loan against the value of a home that does not have to be paid back as long as the owner lives in the home. Simply put, a reverse mortgage allows for some of the equity in a home to be converted into income. Withdrawal of a home’s equity can be completed in three different ways. These proceeds can be paid:
- In a single lump sum
- As regular monthly income
- At particular times and in the amount of the borrower’s choosing
Reverse mortgages typically do not require repayment while the borrower is living in the home. However, they must be paid in full, including interest and any other charges, at:
- The death of the last living borrowing spouse
- After the death of a surviving non-borrowing spouse
- The sale of the home
- The last living borrowing spouse, or non-borrowing surviving spouse, moves permanently away from the home
A surviving spouse does not need to be named on the home’s title and may continue to live in the home without repaying the reverse mortgage.
Some Considerations with Reverse Mortgages
There are several considerations to take into account before taking on a reverse mortgage.
- If there is a first mortgage on a home, it must be paid off before a reverse mortgage will be issued.
- An initial lump sum payment from a reverse mortgage may be used to pay off an existing mortgage.
- Even though a reverse mortgage does not need to be prepaid as long as a person lives in the house, the amount of debt grows over time and ultimately has to be repaid.
- While the amount of debt grows over time, the reverse mortgage repayment cannot exceed the value of the home at the time it is sold.
- Since a reverse mortgage borrower will continue to remain in the home, expenses such as property taxes, hazard insurance, and home maintenance, and home repairs will still need to be paid.
- Reverse mortgage payments are considered income and mya affect eligibility for assistance under certain state and federal programs.
- There are certain upfront costs associated with a reerse mortgage. Origination fees, closing costs, and mortgage insurance premiums are just a few and can be significant.
- A reverse mortgage may be expensive if the loan is repaid within a few years of closing. This means that if a person anticipates moving within a few years of assuming a reverse mortgage, they would be better off exploring another alternative, such as a home equity loan.
- Since the reverse mortgage will be repaid after the last home owner moves out, less equity will be left to any heirs.
The Types of Reverse Mortgages
There are four different types of reverse mortgages that fall under two different categories: public sector reverse mortgages and private sector reverse mortgages.
Public Sector Reverse Mortgages
Available through state and local governments, public sector reverse mortgages are usually the least expensive reverse mortgages and generally can be used for specific purposes only, such as home repair or improvements. Geographic and income requirements also pertain to public sector reverse mortgages.
- Deferred Payment Loans (DPLs): These loans provide a single, lump-sum payment that must be used for home repair and improvements. Many local and some state government agencies. Eligibility requirements vary from program to program. If a home needs repairs or updating, a DPL is an attractive low-cost reverse mortgage alternative.
- Property Tax Deferral Loans (PTDs): These loans provide annual loan advances that can be used to pay property taxes. Eligibility requirements and availability varies widely.
Private Sector Reverse Mortgages
Available from banks, mortgage lenders, and savings associations, the money from a private sector reverse mortgage may be used for any purpose.
- Home Equity Conversion Mortgages (HECMs): These federally-insured loans are backed by the federal government and approved by the Federal Housing Administration (FHA). Any lender may approve this type of loan. HECMs are generally the least costly reverse mortgage that may be used for any purpose.
- Proprietary Reverse Mortgages: These private company reverse mortgages allow the lender proprietary or ownership rights to the loans. This means that they decide which lenders can offer them. These are the most expensive type of reverse mortgage.
It is important to remember that reverse mortgages must be paid back. Whether it is paid back once the last homeowner enters long-term care, moves, or passes away, the loan must be paid back. This will decrease the overall value of any estate and any assets that are to be passed on to any heirs or loved ones.
With the complexity of a reverse mortgage, discussion of your particular situation, retirement wants and goals, and current income levels with a qualified financial planner is key. Since the fees, closing costs, and requirements to obtain a reverse mortgage vary so widely, it is prudent to look at all of the options before deciding on a reverse mortgage.