For most seniors, home equity represents a significant and largely untapped proportion of their wealth in retirement. Although reverse mortgages have traditionally been seen as a last resort for retirees who've exhausted their other assets, they are a very flexible product that can help reduce living expenses and preserve other assets for the future.
"Reverse mortgages are a great way to transfer debt on a house from a current expense to a future liability," said Mark Cortazzo, a CFP and founder of financial advisory firm Macro Consulting Group.
They are also particularly attractive in a low-interest-rate environment.
"They are the one retirement tool that benefits from low interest rates," said Wade Pfau, director of retirement research at McLean Asset Management and a professor at American College. "Not only is the initial principal [borrowing] limit higher but, if borrowers choose to set up a line of credit, the line grows throughout the life of the contract."
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Here's how reverse mortgages work:
If you're at least 62 years old, own your home outright (or have a low existing mortgage balance) and have enough financial resources to continue paying property fees such as taxes and insurance, you're eligible for a reverse mortgage guaranteed by the Federal Housing Administration. You can use the reverse mortgage to pay off that existing low mortgage balance, other debt or even the cost of a new home.
Homeowners are responsible for paying property taxes, home insurance and maintenance costs on the property. You can receive a lump sum or a monthly stream of payments up to a principal limit negotiated at the outset of the contract. That limit is based on the value of your home, expected mortality rates, the lender's profit margin and prevailing interest rates.
The line of credit reverse mortgage is a popular option for senior borrowers when choosing how to access their funds with their reverse mortgage. Borrowers have the option to set up a line of credit that grows at a rate dependent on the lender's margin, the annual FHA insurance premium and short-term interest rates.
Unlike traditional mortgages or home equity loans, the borrower does not make regular payments of principal and interest on the loan. Instead, the lender makes their money on the back end when homeowners either die or sell their home, at which point the loan has to be repaid.