Reverse mortgages have grown in popularity in recent years. In the wake of the recession, our nation's senior citizens were particularly hard-hit, making it difficult to retire using their depleted retirement accounts. But, if they've been able to build equity in their homes, they now have another option to help them through their golden years.
How do reverse mortgages work?
A reverse mortgage is a type of loan that allows you to borrow against your home. Receiving the money as either a lump sum, regular monthly advance, credit line account, or any combination of these options, there are no repayment obligations until the last surviving borrower either sell the home, no longer lives in the home, or passes away. In order to qualify for a reverse mortgage, the borrower(s) must be 62 year of age or older, currently live in their home, and have a large amount of equity in the home.
According to an article on reversemortgagedaily.com, recent changes have been made by the Department of Housing and Urban Development (HUD) to the HECM program. "These changes, which include principal limit reductions of and limits on how much borrowers can draw from their reverse mortgage in the first year of the loan, as well as establishing set asides for borrowers to meet what HUD calls 'mandatory obligations.'" Examples of these new mandatory obligations would be things such as Homeowner's insurance and property taxes.
Basic types of reverse mortgages:
- Federally-insured reverse mortgages - Also known as Home Equity Conversion Mortgages (HECMs).
- Single-purpose reverse mortgages - Offered by some state and local government agencies. Only to be used for a single purpose, such as: home repairs, or paying property taxes. Typically the single-purpose reverse mortgages have a maximum income requirement but remain at a low cost.
- Proprietary reverse mortgages - Privately developed, owned, and insured, this type of reverse mortgage tends to target homes of high value due to the HECM loan's limited capabilities on high valued homes.
The pros and cons of a reverse mortgage:
A reverse mortgage could be exactly what you need for your situation. However, you should look at the pros and cons first to make sure you know exactly what you're getting into. While there are, indeed, many positives to the reverse mortgage, there are also several negative aspects that could surprise you later on. Bankrate.com offers its readers a worksheet that lays out the positives and negatives, we have referred to this worksheet to bring you this portion of the article.
- A reverse mortgage income will not affect Social Security or Medicare benefits (in most cases.)
- If the length of the borrower(s) life exceeds the length of the loan, they will only ever be responsible for paying back the amount the home is worth.
- Most reverse mortgages do not require a minimum income.
- The title to the home remains in the possession of the borrower(s) until they sell the home.
- HECM programs (a type of reverse mortgage) allow the borrower(s) to live in a nursing home or other type of home for 12 months before their reverse mortgage loan becomes due.
- Upon the sale of the home, and the payment of loan and fees to the lender, any remaining equity belongs to the borrower(s) or their heirs.
- A reverse mortgage could potentially have an effect on eligibility for Medicaid.
- Closing costs and origination fees can run high.
- Borrower(s) are required to take part in debt counseling before applying for the loan.
- Servicing fees may be charged to the borrower(s) during the life of the reverse mortgage.
- The debt the borrower(s) owe(s) increases over time due to interest being charged to the outstanding balance of the loan.
- Short-term indexes, such as the one-year Treasury bill or LIBOR, are tied to variable interest rates.
- Little assets left to leave to heirs if equity is used up.
- The interest on the loan is not tax-deductible until the loan is paid off.
- While receiving the payments, borrower(s) are responsible for continuing to pay taxes, homeowners insurance, maintenance costs, etc. If they do not do so, the loan may become due early.
Do you need a reverse mortgage?
This is a type of loan that, while it can be helpful at times, can also be quite expensive and risky in the long run. Think about what you would use the money from the reverse mortgage for? Is there another way you could obtain that money that would be less risky? The reason for taking out this loan should be as serious as the risk you're taking.
Reasons you should NOT reconsider taking out a reverse mortgage:
- Purchase a large item (i.e. car, boat, etc.)
- Investment opportunity
Reasons you should consider taking out a reverse mortgage:
- Maintain financial independence in the absence of a steady income
- Supplement social security income
- Help pay for day-to-day needs
- Cover the cost of extensive medical bills and prescriptions
Is there an alternative to a reverse mortgage:
If you find that your initial reason for wanting a reverse mortgage doesn't seem worth the risk anymore, there may be other options available to you.
- Home Equity Loan - This is a type of loan that you can borrow, at a fixed amount, by using your home as collateral. This loan is paid out in a lump sum and is then repaid by you in equal monthly payments over a specific amount of time. This is a good option if you can afford to make monthly payments. If you cannot afford monthly payments, this is not a good option, as the bank could foreclose on your home if you do not repay the loan.
- Home Equity Line of Credit (HELOC) - This is a form of "revolving credit" where your home also serves as collateral. However, instead of receiving a lump sum for a loan, you are approved for a specific amount of credit. This amount is decided by subtracting the balance owed on the mortgage from a percentage of the home's appraised value (chosen by the lender). Typically used for things such as education costs, large home improvements, and medical expenses.
- Downsizing - Selling your current home and moving to a location with a lower cost of living might prove to be quite economical if your reason for considering a reverse mortgage was to keep up with day-to-day needs. Selling your home and purchasing a much smaller home would leave you with extra money, while a reverse mortgage would possibly leave your heirs with debt.
Can you cancel a reverse mortgage:
We all change our minds. Unfortunately, in some cases it's not an option. With a reverse mortgage, however, you have the option to cancel your reverse mortgage within three business days of the transaction. If you do choose to cancel your reverse mortgage, you must inform the lender of this decision in writing. Prior to midnight on the third business day, your notice of cancelation must reach the lender by mail, electronic filing or hand-delivered.
When you cancel:
- All security interest in your home is cancelled, freeing you from any liability.
- Your lender will return all money and/or property to you within 20 days.
- You may keep any money and/or property that was given to you by the creditor until proof of your home no longer being used as collateral is presented. You must offer to return it, however, if they do not claim within 20 days, it is yours to keep.
Click here to learn more information about reverse mortgages, or you can call one of our Reverse Mortgage Counselors at (888) 764-7460.