Mortgages come in many shapes and sizes. There is a good chance you have probably heard of reverse mortgage but if not, you have come to the right place.
When getting a home loan to buy a house, you make payments to the lender. However, the concept in reverse mortgages is the opposite. In reverse mortgages, the lender makes payments to you. These payments can either be monthly or in a lump sum amount. Let’s take a more detailed look at what a reverse mortgage is.
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What is a Reverse Mortgage?
A reverse mortgage is a type of cash-out refinancing that gives property owners above the age of 62 a chance to convert their real estate equity into liquid cash. This type of loan is secured against a residential property that gives retirees added income.
Just hearing about the fact that you get to turn your real estate equity into spendable cash may excite you but the truth is, reverse mortgages can be extremely controversial.
Some people think reverse mortgages are a good idea for retirees who need extra money. Reverse mortgages allow them to tap into their property, likely to be their most valuable asset and cash it.
On the other hand, critics point out the disadvantages of reverse mortgage such as the high fees, loan balance increases and the fact that the reverse mortgages not made through an FHA program can lead to a lack of consumer protection. This can end up leaving you or your heirs out in the rain without shelter if your home loses value.
But it is a good thing that we have compiled a list of pros and cons of reverse mortgages for seniors so you can make your decision better.
Reverse Mortgage Requirements
A reverse mortgage is a type of FHA loan that is known as a HECM loan. Some lenders tend to offer proprietary (non-FHA insured) reverse mortgages but most of the loans offered are by the lenders who use the HECM program through FHA.
It is important to consider focusing on programs that are already FHA-insured and adhere to federal guidelines when you are considering a reverse mortgage. This is important as with non-HECM reverse mortgages, you could end up losing important consumer protections and not be guaranteed the requirements provided by the FHA.
The following requirements are to be met in order to qualify for a reverse mortgage:
- At least 62 years of age.
- Home must be the primary residence.
- Must not be delinquent on federal debt.
- Keep paying insurance, taxes and other costs.
- Property must meet FHA requirements.
You can either set up a term to receive payments or receive them as long as you are alive and live in the home. You can even use a line of credit for the reverse mortgage. Regardless of the type of payment setup you pick, you will not be forced to sell your home in order to pay off the mortgage nor will you have to make payments if you are no longer living in the home.
By now you might be thinking reverse mortgage is a good idea, you’re not wrong. It can make good sense in some situations. However, there are certain drawbacks to the mortgage as well. Let’s talk about the pros and cons of reverse mortgages in detail.
What are the Pros and Cons of a Reverse Mortgage?
Reverse Mortgage Pros:
- Regular income during retirement.
Once you retire, it is hard to find regular income to meet your expenses. Pensions are usually not enough but as long as you remain in the home and use it as your primary residence, you can end up receiving regular income while being retired. This is especially a big help for retirees that are too sick to work and struggle to meet their living expenses as their pension is not enough.
The amount you can borrow in order to meet your expenses depends on the current interest rate, age of the youngest borrower and the current value of your home. According to the FHA, the amount of the equity you have in your home is also considered if you have paid a considerable amount rather than owning the home outright.
With a reverse mortgage, you can receive equal payments for the rest of your life or as long as you live in the home. An alternative to reverse mortgage is if you get these payments for a set time period. However, this will have the risk of you not having enough income and outliving your payments.
But if you end up doing it, you will have income during retirement which can in return supplement your other retirement resources.
- You do not have to pay taxes on the money you receive.
When you are looking for solutions to a tax efficient strategy in managing your retirement income, a reverse mortgage can help. You can get away with not paying taxes on the money you receive from the lender as tax is not a requirement for reverse mortgages.
Moreover, since the IRS does not consider reverse mortgage actual income but a loan, it would not be counted in formulas that use your income to determine what benefits you receive, etc, such as social security and medicare benefits.
- It is a non-recourse loan.
People often worry what will happen to their reverse mortgage if their home loses value. However, you need not worry about paying any extra if your home does not sell for what you owe. FHA mortgage insurance can cover any difference between the sale price of the home and what you owe. But for this to happen, the home has to sell for 95% of its appraised value.
So if your home ends up selling for less than you owe, you do not have to worry about it if the sales price is still within the boundaries set by the government.
- You cannot be forced into early repayment.
You would not be required to repay your reverse mortgage. The only way you might have to is if you do not use the home as your primary residence, sell the home or die. Otherwise, you would not be forced into early repayment.
Once you sell the home, you have to use the proceeds to pay off any remaining loan balance you have. However, if the home sells for more than what you owe, you are welcome to keep the difference and use it for whatever you like.
If you die, your loan might have to be repaid by your heirs. If your estate cannot afford the loan, your heirs might be required to sell off the property and use the proceeds from the sale to repay the loan. However, the heirs are not expected to pay more than the home’s current market value so they do not have to stress about their home losing value.
Reverse Mortgage Cons
Even though being able to cash out your home’s equity seems like a good idea, it can have certain drawbacks as well.
- Age limit to qualify for reverse mortgage.
In order for reverse mortgage to be insured through the FHA, you cannot be younger than 62. If you have a spouse that is below the age of 62, it might end up affecting your reverse mortgage process.
You can get around this rule by deeding the home to the older spouse and not including the non-qualifying spouse in the reverse mortgage. However, this strategy can end up causing issues later. So if both the spouses do not meet the FHA-insured reverse mortgage age requirement, it would be wise to wait until they do.
If you have a non-FHA-insured reverse mortgage, the terms of the policy may be different and may not offer as much protection.
- There are various costs.
You could have several costs to take care of when you decide to get a reverse mortgage. Here is a list of fees that come with a reverse mortgage, including:
- Mortgage Insurance which requires an initial premium of 2% of the loan along with 0.5% of the annual outstanding loan balance each year.
- Closing costs which are third-party charges, can vary depending on the lender.
- Origination fees which can be charged up to $6,000 by lenders based on your home’s value.
- Servicing fees which are allowed by the FHA for lenders to charge monthly.
These fees can be included in your loan which will reduce the amount you receive from the lender.
- Your heirs might not afford to keep the home.
You might not be able to pass off the home to your children or other heirs if your estate does not have enough in assets to pay off the loan.
Once you die, your heirs will have to pay off your loan. If they cannot figure out a way to pay it off using other resources, the home would have to be sold instead of keeping it.
Which is why it is important to double check that you have a back up plan to pay off your estate or life insurance before you even get a reverse mortgage. This is especially important if you want to keep the property in the family.
- Loan is pending if you move into long term care.
You can continue living in your home without worrying about making a payment. However, if you move into long term care and do not live in the home for the majority of the year, your loan could come due. Once that happens, you would have to sell off the house or use other funds to help pay it off.
Even if you do not have to make mortgage payments, you are still responsible for paying the property tax, homeowners insurance and maintenance. If you fail to make these payments on time, your home can be foreclosed.
It is important to make sure you have the money required to make these payments when you are getting a reverse mortgage otherwise you could risk foreclosure.
Some lenders even create a “set-aside” account so you could deal with these costs by putting a portion of the payments into the account just so you can keep them aside and not spend them. However, this “set-aside” account does not mean you will always have money for these costs if you do not pay attention and stay up-to-date.
So what we can see is that a reverse mortgage is just like any other financial tool with its fair share of advantages and disadvantages. But in order for it to work in your favour, all you have to do is understand it fully before making a huge decision that can cost you in the future if not well thought out. You also need to see how it fits into your finances. To help you make these important decisions, you can use the help of a financial advisor or real estate attorney so they can tell you what the pros and cons of a reverse mortgage are and whether it is the right fit for you.