Reverse mortgages have some pros and some cons for seniors

  • More than 1 million reverse mortgages, or Home Equity Conversion Mortgages, have been sold since the government program that insures them started in 1990.
  • There are three types of HECMs — the standard HECM, HECM for Purchase and HECM Refinance — and most (90 percent) are insured by the Federal Housing Administration.
  • Reverse mortgages are an attractive option for certain seniors, but those with good credit and enough income to make monthly payments should look into cheaper alternatives.

Reverse mortgages are a unique type of loan. Unique is a word that is thrown around a great deal, particularly when describing financial products. But it's accurate when describing Home Equity Conversion Mortgages — another term for reverse mortgages.

Here are three reasons: You don't have to make payments on these loans until you die or move, they are restricted to homeowners who are 62 or older, and reverse mortgages use two interest rates for every transaction: one to calculate your mortgage rate, and another to calculate your expected rate, which determines how much money you can borrow.

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It's no wonder the reverse mortgage is one of the most misunderstood mortgage products around. That was fine when reverse mortgages were an exotic loan product that few people purchased. However, more than 1 million have been sold since the government program that insures them started in 1990.

So, what is a reverse mortgage? A reverse mortgage is a loan that uses a primary residential home as collateral. In that sense, it's like a traditional mortgage. However, unlike regular mortgages, the amount a borrower owes on a reverse mortgage increases over time, and payment is only due when the homeowner no longer lives in the property.

There are three main types of reverse mortgages. Most of them – around 90 percent – are insured by the Federal Housing Administration. There is the standard HECM, which you can use as a line of credit, a monthly installment or a lump sum. There is also an HECM for Purchase, which borrowers use to buy a home and finally there's an HECM Refinance, which allows you to convert an existing HECM into a new HECM, to either benefit from lower rates or borrow more money.

What are the benefits and disadvantages? The main benefit of a reverse mortgage is that the borrower's credit is not a deal breaker when it comes to approval. The key factors are the value of the house, the loan amount and the age of the borrower.

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In 2018, senior home equity hit $6.8 trillion and it continues to grow. This makes reverse mortgages a particularly attractive option for some senior homeowners. Note that even if the value of your home drops, the homeowner's heirs will never owe more than the value of the home when it is sold.

If the value of your home holds or rises, the homeowner or the heirs could be left with some equity when the house is finally sold. As long as property taxes and insurance is paid, they can never be forced to leave the home. These are attractive benefits for elderly homeowners who are struggling to make ends meet.

However, there are serious disadvantages to consider. For example, reverse mortgages reduce the inheritance you leave for your heirs. Unless they pay off the reverse mortgage, they will not inherit the house. Also, HECMs are not cheap. They are expensive when compared to home equity lines of credit and second mortgages, particularly when you consider the mortgage insurance premium.

Something important to consider is that fees and costs vary significantly from one reverse mortgage to another. Homeowners can save a great deal of money by shopping around and comparing terms. It pays to shop around and get quotes before choosing a lender. You are also restricted from leaving your home for more than a year, and there is no annual tax deduction for interest.

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What do you need to do before you get a reverse mortgage? To qualify for a reverse mortgage, you must be 62 or older, have a property with considerable equity, and use it as your primary residence. You can't be delinquent on any federal debt, and you must prove you can afford to keep up with property expenses, such as taxes, insurance and maintenance. Be prepared to prove you have enough savings or income to cover these costs. The property must also meet all FHA standards and flood requirements.

When should you consider a reverse mortgage? Reverse mortgages are not a cheap way to borrow money when compared to home loans. Senior citizens with good credit and enough income to make monthly payments should look into cheaper alternatives, such as a home equity loan or a second mortgage, before even considering reverse mortgages.

However, reverse mortgages are a good option when you have equity in your home, not much cash in the bank and you want to stay in your home. It is a good option for homeowners who don't have access to cheaper forms of credit and need money for living expenses. Not surprisingly, reverse mortgages peaked in popularity from 2007 to 2009, during the worst years of the recent financial crisis.

Because reverse mortgages are often a loan of last resort, there is a negative bias against them. Nevertheless, they can be an excellent source of tax-free income for older homeowners with low incomes.

— By Miron Lulic, founder and CEO at SuperMoney

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