The Reverse Mortgage has long been viewed as a last resort for older Americans with home equity but little cash. Regulators and financial services firms are hoping that changes and reverse mortgages become a mainstream financial strategy. You should be cautious about jumping in. First the basics: A reverse mortgage is a type of loan which allows seniors to access the equity in their homes without having to pass credit or income requirements. The qualifications for a reverse mortgage include the owner being at least 62 years old, that the home is occupied by the owner and that the owner has equity in the home.
The loan can be taken as a lump sum, lifetime payments, or a line of credit. It doesn’t have to be repaid until you move or die.
Total Annual Loan Cost
Although the interest rate on an HECM mortgage is set by the government, and the origination cost of an HECM loan is limited to 2% of the value of your home, the total cost of the loan can still vary by lender. Furthermore, in looking for a lender, borrowers must consider third-party closing costs, mortgage insurance, and the servicing fee. To assist borrowers in comparing mortgage costs, the federal ‘truth-in-lending law’ requires mortgage providers to present borrowers with a cost disclosure in the form of the total annual loan cost (TALC). Do be sure to use this number when comparing loans from different vendors; just keep in mind that the actual costs of a reverse mortgage will depend largely on the income options selected.
Interest RatesThe interest rate on HECM reverse mortgages is tied to the one-year U.S. Treasury security rate. Borrowers have the option to select an interest rate that can change every year or one that can change every month. A yearly adjustable rate changes by the same rate as any increase or decrease in the one-year U.S. Treasury security rate. This annual adjustable rate is capped at 2% per year or 5% over the life of the loan. A monthly adjustable rate mortgage (ARM) begins with a lower interest rate than the ARM and adjusts each month. It can move up or down 10% over the life of the loan.
A reverse mortgage is typically structured so that the total loan amount, including interest and fees, will not exceed the value of the home over the life of the loan. However, if the proceeds from your home’s sale exceed the balance of the loan, then you, your spouse, or your heirs will receive the difference. Should the sale not cover the loan balance, then, in most cases, the lenders insurance will cover the difference.
As with conventional mortgages, reverse mortgage lenders make money the old-fashioned way: through interest, origination fees and points. The interest rate varies according to the market. However, closing costs are significantly higher with reverse mortgages.
In addition, borrowers continue to be responsible for real estate taxes, conventional homeowners insurance and home repairs, and have the added burden of paying for mortgage insurance, too.
Why would borrowers have to pay mortgage insurance? After all, that insurance is required for regular mortgages if borrowers don’t have a large enough down payment, and its purpose is to protect lenders in the event of a default. With a reverse mortgage, there’s no such risk to lenders.
But other risks exist. Mortgage insurance guarantees the lender will receive its full repayment. For example, a decrease in the property’s value adversely affects the lender’s reimbursement. Mortgage insurance also covers the lender in the event the mortgage is held over a very long period of time and accrued interest exceeds the value of the home.
Pros of Reverse Mortgages
- Reverse Mortgages Are A Source Of Income – When you take equity out of your home through reverse mortgage, you can decide on receiving a line of credit, payments or even a lump sum. For those living on a fixed income, you can supplement your income by taking a reverse mortgage and choosing the fixed payments option.
- Tax Benefits – Because the income from a reverse mortgage qualifies as a loan, the proceeds are generally tax free. However, you would want to consult your tax attorney for more specifics related to the tax implications of doing a reverse mortgage.
- Generally No Social Security Or Medicare Implications – Though reverse mortgages can be used to provide fixed payments to the homeowner, there are usually no penalties relating to social security or Medicare payments that the homeowner may currently receive.
- You Will Never Owe More Than The Home’s Value – A reverse mortgage allows you to receive fixed payments, and it is possible to receive more in payments than the value of the home. However, according to FTC guidelines, you will never owe the lender more than the home is worth.
- Equity Overage Is Yours – You or your beneficiaries will receive the overage if the home if sold for more than the loan amount.
- Title Retention – The title to the home remains in the name of the homeowner.
Cons of Reverse Mortgages
- Potential Medicaid Impact – It is possible that Medicaid eligibility could be affected by a reverse mortgage.
- Fees – In processing a reverse mortgage, lenders generally charge origination and closing costs which can equal several percentage points of the home’s value.
- Debt Counseling Requirement – Homeowners must go through mandatory debt counseling as a pre-requisite to obtaining the loan. This is meant to make sure the homeowner is fully informed about all the aspects of their decision. But, it can come off as a hassle.
- Interest Rate – Many reverse mortgage options offer variable rates. Interest rates are currently near historic lows, but could rise significantly over the course of the loan.
- Taxes And Home Owner’s Insurance – With a reverse mortgage, the home owner is still responsible for paying homeowner’s insurance and taxes. Failure to make these payments could cause the loan to be called due prematurely.
- Home Equity Used – Your home equity will be consumed by taking the mortgage. You will have fewer assets to leave to your family as a result.
Taking out a loan against your home is a big decision that will impact your current finances and the estate that you leave to your heirs. There are substantial costs involved, including loan origination, servicing, and interest. You also need to remember that, with a reverse mortgage, your debt increases over time due to the interest on the loan. If you change your mind about the loan, or need to move out of the property due to health reasons, proceeds from the sale of the property are used to pay off the reverse mortgage. Depending on the size of the loan and the value of the property, there may be little or no money remaining after the loan is repaid.
A reverse mortgage isn’t right for everyone. You should consult a financial professional who is familiar with your situation before you would take this option. Although being able to access the equity in your house without having to make monthly payments is attractive, the costs and fees associated with a reverse mortgage are negatives that must be considered. People should remember they might not be able to bequeath their house to heirs, which could also be a significant deterrent.
Before taking out a reverse mortgage, you should research the topic thoroughly, compare costs from a variety of lenders, and read all disclosure documents. While investing the proceeds from a reverse mortgage is generally not advisable because of the need to recoup the costs of the loan plus the interest, the income from a reverse mortgage may provide an opportunity to refocus other elements of your investment portfolio. Prior to assuming the mortgage, consider the cash flow the reverse mortgage will provide and review the implications this new source of income will have on your overall investment strategy.