If you're thinking about a reverse mortgage, be prepared to learn a lot about a complicated financial commitment.
With a reverse mortgage, you can convert part of the equity in your home into cash instead of selling, provided you're at least 62 years old. As long as you continue paying taxes and maintaining the home, you cannot be evicted.
It may sound like the answer to your retirement cash prayers, but complexity and costs are among the factors to consider.
Here's how it works. Instead of a debt that gets lower as you make payments to the bank for a regular mortgage, a reverse mortgage is the exact opposite.
You draw out funds and interest builds up, while the balance grows larger and you hold less equity in your home.
Keep in mind, you must use the funds to first pay off any existing mortgage on your home.
For loans insured by the federal government, the amount you can borrow depends on the age of the youngest borrower, current interest rates and either your home's appraised value or the $765,600 maximum set by the Federal Housing Administration — whichever is smaller.
You don't repay the lender until you permanently move out or die.
Payments to you vary widely with different types of reverse mortgages. Possibilities include a one-time payment, monthly payments, or leaving the funds in a line-of-credit that can grow over time if unused or some combination of options.
Most popular is the variable-rate home equity conversion mortgage, according to Wade Pfau, professor of retirement income at the American College, in Bryn Mawr, Pennsylvania. This type of mortgage, aka an HECM, is insured by the Federal Housing Administration and offers several payment options.
Other arrangements are the proprietary reverse mortgage, a private loan backed by a company, and the single-purpose reverse mortgage offered by some state or local government agencies.
When you're considering a reverse mortgage, ask yourself if the house will work for you the rest of your life, says Carolyn McClanahan, a physician and certified financial planner who is founder and director of financial planning at Life Planning Partners in Jacksonville, Florida. Scout other possibilities, she advises, such as selling the house so you can use the money for a less-expensive property or to rent.
With a reverse mortgage, you have to be sure you can afford your home forever, McClanahan says.
On the plus side of a reverse mortgage, there are two pros:
- You can tap equity in your home without having to sell.
- You can keep the title to your home.
On the minus side? Here are the cons:
- High fees: The biggest cost is an initial mortgage insurance premium equal to 2% of the appraised value. "The origination fee might be higher than with a traditional mortgage," Pfau said.
- No one living with you under the age of 62 may be a borrower on the reverse mortgage.
- You leave less money to your heirs.
Applications for reverse mortgages rose 15% in March from the previous month as people turned to the loans to avoid tapping retirement investments in a down market.
And there's another potential reason we'll see more interest in reverse mortgages. Although retirement communities and assisted living facilities have become more common in recent decades, the current Covid-19 pandemic may make large groups of older people living together in one place look like not such a good idea after all, McClanahan says.
This new dynamic could mean that more people will try to age in place instead of selling and moving.
Having more equity built up in the home than in savings is a common reason for turning to a reverse mortgage.
In other words, some people are "home-rich and cash-poor," Pfau said. "They might not have a lot of savings."
Several factors should be in place for a reverse mortgage to work.
″[For] an older person who has a home that is aging-friendly in a community that's also aging-friendly, it's probably an OK idea," McClanahan said.
A good strategy could be taking some of the initial money and putting it into modifications to make the home adaptable for someone as they age.
Someone who's financially responsible could benefit. "Don't use [a reverse mortgage] because you want a bunch of money to buy a boat," Pfau said. "If someone can't deal with having the cash, they might be better having their home equity tied up and not available."
A reverse mortgage needs to be a family discussion. "Make sure the children understand," McClanahan said. "We have a huge problem, in that people don't talk over their finances with their children until they are in trouble."
Some families might be able to avoid actually using a reverse mortgage. A client of McClanahan's created his own version, in which he paid his father to help with his living expenses. The son inherited the house when the father died.
Since 2015, people who want a reverse mortgage must undergo a financial assessment to demonstrate they can maintain the home and keep up with property taxes and other costs associated with ownership.
You generally have up to a year after moving out to either sell or come up with the repayment, Pfau says. The category of non-borrowing spouse, created in 2015, means the remaining spouse can remain in the house.
The home must be your primary residence, and you can't be delinquent on any federal debt.
You have to participate in counseling with a HUD-approved counselor who specializes in home equity conversion mortgages. Counseling is a good idea, McClanahan says. "When people are doing these reverse mortgages, they need the money so much they discount the bad things that could happen," she said.
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