Reverse Mortgages: Know the Risks and Rewards
As far as I am concerned, retirees have been the most innocent of victims of the financial crisis. During the past two and a half years the aggressive action of the Federal Reserve to lower short-term interest rates, while sound policy, has nonetheless created great hardship for retirees who rely on safe interest income to to live on. Yields on bank and credit union deposits, as well as short-term Treasury bills, are below 2 percent. It’s hard to make ends meet with that paltry payout.
So I completely understand when retirees come to me and ask what I think about taking out a reverse mortgage on their home. It sounds so enticing. You tap the equity you have in your home, owe no money to the bank as long as you stay in the home, and you can suddenly have $1,000, $2,000, or more income each month. It sure seems like such a great lifesaver.
But I ask every retiree — and the grown children of retirees who are looking out for the best interests of their parents — to be very carefuI. A reverse mortgage can end up sinking you financially.
The biggest risk with a reverse mortgage is that you do not stand in the truth of your situation. While a reverse mortgage can indeed be a viable way to generate income, it is very important to understand that after you take out a reverse mortgage you will still be responsible for paying the property tax, the insurance premium, and all the maintenance costs for your home. If you can’t continue to cover those costs you will risk losing your home to foreclosure. That’s exactly what many retirees who already have a reverse are facing today. (Just check out this note from the Federal Housing Administration, which insures the majority of reverse mortgages. The FHA is well aware it has a growing problem on its hands.) I don’t want you to end up in such a sad predicament.
As I explain in my new book, The Money Class, the only way to create true security is to Stand in Your Truth. By that I mean carefully assessing what is real for you today. Not what you had in the past, or what may have “worked” for you in the past. And not what you hope or wish your future holds. Security tomorrow depends on a clear-eyed assessment of what is true and honest for us today. For retirees, there may be no more important Stand in the Truth act than to honestly assess whether a reverse mortgage will actually solve your income shortfall, or whether it is just temporarily masking the fact that you really can’t afford to stay in your home.
In the following excerpt from The Money Class I explain how you should carefully size up whether a reverse mortgage is right for you:
LESSON 7. REVERSE MORTGAGES
In the coming years I expect reverse mortgages to become increasingly popular among retirees who are eager to find extra income. A reverse mortgage is available to anyone who is at least 62 years old and owns a home outright, or has a small mortgage balance remaining.
If you are married and both spouses are on the home’s title, the youngest spouse must be 62 before you can consider a reverse. With a reverse the borrower can opt to receive a lump payment, or an ongoing payment for a set period of time, or a line of credit in which the home equity is the collateral for the loan. It is literally a way for retirees to live off their homes. While I think a reverse can make sense in certain circumstances,it is not nearly the win-win it is often made out to be. There are many costs and risks to doing a reverse that you mustfully understand.
REVERSE MORTGAGE BASICS
The vast majority of reverse mortgages are loans that are insured by the Federal Housing Administration. The formal name for these FHA- insured loans is Home Equity Conversion Mortgage (HECM). The maximum home value that can be tapped for an HECM is based on home values in your area. The upper limit in 2011 for people living in high- cost areas is $625,500. But that is just a limit used to calculate the benefit you can receive; in fact, no one can receive a payment anywhere near the full value of their home; typically your original loan amount might be 60% or so of your equity.
The percentage of your equity that you can tap is based on a calculation that factors in your age and current interest rates. Your credit score is not a factor.
The younger you are, the less you can borrow
The younger you are the less you can borrow. For example, in early 2011 a 62-year-old with a fully paid- off mortgage and a home value of $625,500 in a high-cost area might qualify for a maximum reverse mortgage of about $365,000. A 72-year-old might qualify for a $392,000 payment. All reverse mortgage payments you receive are tax-free.
I realize that sounds like a lot of money — it is a lot of money — but what you must realize is that once you borrow the money your account begins to ring up interest charges. You never have to repay a penny while you live in the home. But when you move, or you die, the loan must be repaid. (If you move into an assisted living facility or nursing home for more than twelve months you are deemed to no longer live in your home, and the reverse loan must be repaid.) And you, or your heirs, will owe the principal and the interest. Now one great aspect of a reverse mortgage is that you will never owe more than the value of your home when you leave, but every penny of the sale could well indeed go to the reverse mortgage lender to settle your loan—meaning you or your heirs may not have any equity left when all is said and done.
Another consideration is the cost. Traditionally, reverse mortgages have been quite expensive. The up- front fees to open a standard HECM reverse mortgage can add up to 10% of the loan amount. In late 2010 a new type of reverse, called the HECM Saver, was introduced. It eliminates many of the up-front fees, though the amount you can borrow through the program is about 15% or so lower than what is available with a standard reverse mortgage. In both versions you will pay an ongoing annual “insurance” premium of 1.25% of your loan amount.
I have to say that I think reverse mortgages are a potentially dangerous step for many retirees. It is far too easy to get blinded by the prospect of receiving much- needed income today and overlook some important considerations.
Please understand that after you take out a reverse mortgage you are still responsible for all costs associated with running your home— the property tax bill, the insurance bill, the utilities, and all maintenance costs. If you can’t afford the upkeep of your home it makes no sense to do a reverse mortgage. You will just end up having to sell eventually when you realize you can’t afford the home, and whether you have any equity left after the sale depends on the size of the reverse loan that must be settled.
And as I mentioned, a reverse will also impact the estate you leave for your heirs. When you die, the loan comes due. The lender cannot charge more than the value of the home, but every penny of the sale could in fact go to the lender, leaving your heirs without an inheritance. I also want you to know that if your heirs decide they want to keep the home after you pass, they would in fact owe the lender the full value of the loan, even if it exceeds the sale value of the home. For example, if your reverse mortgage balance is $300,000 when you move or die, and the home sells for $260,000, the lender will receive just the $260,000. You or your heirs would not need to come up with another $40,000 to settle the loan. But if your heirs decided they in fact wanted to keep the house, then they would owe the full $300,000.
My recommendation is that you think of a reverse mortgage as a last- resort emergency fund in retirement, not a primary piece of your retirement plan from day one. If money is so tight at age 62 that you think you need a reverse mortgage, my concern is what happens at age 72 or 82? If you tap all your home equity through a reverse at 62 and then at 72 you realize you can’t really afford the home, you will have to sell the home, and you may end up giving most or all of the sale price back to the lender to settle up.
What will you live on then? I would much rather you base your retirement on other income sources— your savings, Social Security, and a pension. If later on in retirement you need extra income, then you can consider a reverse mortgage, but go in with your eyes open.
You can learn more about reverse mortgages at the Housing and Urban Development Web site.
You can calculate an estimate of what you might be able to receive from a reverse mortgage using NRMLA's calculator