How to Do a Reverse Mortgage Right (Or Not At All)
Reverse mortgages represent an alluring proposition for seniors: Stay in your own home while the bank pays you either a lump sum or a stream of payments to help supplement your retirement income.
For some, that arrangement can help bring peace of mind. Others will scoff at the hefty fees and restrictions involved. And in many cases, alternative options, such as using one's home as collateral for a loan from a family member, might be a better fit.
Types of reverse mortgages vary, but generally, a reverse mortgage allows homeowners age 62 or older to borrow against their home's equity. They can opt for a lump sum, line of credit or regular payments, and don't have to pay a monthly mortgage. The homeowner retains title and must pay insurance and property taxes while living there.
The loan and fees are due once all parties listed on the deed die, or the home is vacated for 12 straight months. The home is usually sold, and the proceeds from the sale are used to pay off the loan, plus interest and fees.
The interest on the loan balance is typically calculated monthly and accrues over time. So, if you elect to receive regular payouts, for example, the amount you owe, plus interest, grows. When the loan is repaid, the lender also collects all the compounded interest.
Here are six tips experts recommend when considering whether to get a reverse mortgage:
1. PUT IT OFF
Even though homeowners can qualify for a reverse mortgage as early as age 62, experts suggest putting it off as long as possible.
The longer you wait, the more you can borrow against your equity. You also stand to save more money on interest if you put off the timing of the loan or when you start receiving payments. Since, the longer the loan period, the more interest adds up.
Another consideration: the sooner you start depleting your home equity, the greater the chance that you may not have enough to meet your needs when you're older, says Noreen Perrotta, finance editor at Consumer Reports.
"The troubling trend now is that people are taking reverse mortgages as soon as they're qualified to do so," she says. "Life expectancy being what it is, if you're tapping your home equity at 62, you have to wonder what's going to be left at 82."
While reverse mortgages are intended to supplement retirement income, many borrowers are opting to take out loans at younger ages. That could increase the risk that they will go broke later in life, according to a report issued in June by the Consumer Financial Protection Bureau.
2. UNDERSTAND REVERSE MORTGAGE TYPES
Reverse mortgages generally fall into three categories, Home Equity Conversion Mortgages, or HECMs, which are backed by the federal government; proprietary reverse mortgages, which are essentially private loans; and, single-purpose reverse mortgages, which come with restrictions as to what you can spend the money on.
By far, the more commonly available reverse mortgages today are the HECMs. That's because, as with other types of home loans, the government has become the main purchaser of reverse mortgages since the housing collapse.
Lenders approved by the Federal Housing Administration offer HECMs, which makes the loans widely available. Borrowers don't have to meet any income, credit or medical criteria to qualify, and are free to use the funds any way they please.
The Federal Trade Commission says most homeowners with a low or moderate income can qualify for the single-purpose loans, which also are the least expensive. But they may not be available in all areas.
3. EVALUATE FEES AND INTEREST RATES
Reverse mortgages involve a slew of fees, such costs for closing and servicing the loan, origination fees, a premium for mortgage insurance (in the case of federally backed loans), and, of course, the interest rate.
For HECMs, origination fees can range from 2.1 percent to 8.3 percent of the loan amount, depending on the home's loan-to-value ratio. Mortgage insurance premiums on HECMs are charged monthly and based on an annual rate of 1.25 percent of the loan balance.
Like regular home loans, reverse mortgages can come with a fixed interest rate or one that's adjustable, meaning it can rise or fall over time. ARMs also can potentially lessen the amount of equity available to the borrower, because more of the equity could end up going toward interest.
In the case of a HECM, the borrower is required to meet with a counselor from an independent housing agency who must explain how much the loan will cost, as well as possible alternatives, according to the FTC.
4. AVOID LUMP SUM PAYOUT
Generally, reverse mortgages that come with a fixed interest rate require the borrower to take the lump sum payout, and some 70 percent of reverse mortgage borrowers opt for the one-time payment, according to the Consumer Financial Protection Bureau.
That option makes sense for borrowers who want to get as much of their money as they can at once. Many borrowers who opt for the one-time payment do so as a way to refinance traditional mortgages or make another large purchase.
But it puts them in a position where they have to manage that money, while continuing to pay their property taxes, homeowner's insurance, upkeep on the home and other costs. And if they should run out of money, they could lose the home to foreclosure.
Some 9.4 percent of reverse mortgage borrowers are at risk of foreclosure because they haven't paid taxes and insurance, according to a report by the CFPB.
Also, if you don't need all the money at once, you end up paying more interest than you're earning.
A better option for those looking for a steady stream of income is to take a credit line, suggests Jack Guttentag, professor of finance emeritus at the Wharton School of the University of Pennsylvania and operator of mortgage information website MTGprofessor.com.
Such an option is only available as an adjustable-rate loan, but borrowers can elect not to draw on the credit line only as needed, preserving their home equity.
In contrast, borrowers who take the lump sum payout can end up paying more than 5 percent in fees, Guttentag says.
"And where are you going to invest today to earn more than 5 percent?" he says.
5. CONSIDER HEALTH CARE NEEDS
If a borrower becomes ill and has to be moved to an assisted living facility for more than 12 months, their reverse mortgage will come due, because reverse mortgages require borrowers to live in their home.
In the case where a borrower's spouse has yet to turn 62, should the borrower become ill and leave the property for more than 12 months or die, the loan also would come due.
6. EXPLORE ALTERNATIVES
Homeowners should investigate whether there are any alternatives available before borrowing against the equity in their home, particularly if they're weighing drawing funds soon after they meet the minimum age requirement.
"If you have to tap it at that early age, you might be better off selling the home," Perrotta says.
The advantage of selling a home is you can draw all the equity you have built up. In a reverse mortgage, you only get a portion of that, because you have to cover the fees and interest costs.
Of course, if you sell your home, you have to find and pay for a new place to live. Some options include moving into a smaller, more affordable home.
Another option: Selling the property to relatives and then renting it back from them so the property stays in the family.