Reverse mortgages are a financial tool that has been pushed aggressively over the past decade or so, leading to difficulties for many people – especially seniors – who utilized the tool without understanding the risks. Like any loan, a reverse mortgage can be extremely useful, allowing homeowners to take advantage of the equity in their home to cover other expenses. However, there are risks to choosing a reverse mortgage that you should have a firm grasp of before you choose to apply for one.
Many people often wonder how does a reverse mortgage work?
Unlike conventional mortgages with a reverse mortgage, there are no payments involved. Instead, the lender makes payments to the borrower either through a lump sum, monthly payments, or a line of credit.
A reverse mortgage is repaid when the borrower dies, permanently moves from the home, or the property is sold. Instead of you paying the bank monthly and the equity in your home growing, the bank pays you monthly, and the equity could possibly shrink. A good way to think about a reverse mortgage is a potential way to finance your retirement.
The following information will help you understand the main pros and cons of a reverse mortgage. Educate yourself and consider your options carefully before you make a decision one way or the other. By being informed, you can choose the right course of action for your specific situation and your needs.
Who qualifies for a reverse mortgage? One of the first things most people wonder is who qualifies to receive this type of loan. In order to apply for a reverse mortgage you need to be 62 year of age, own your home outright or have a low mortgage balance that can easily be paid off. Owners applying for this type of mortgage must also be able to pay for taxes, insurance and upkeep around the home. The property must also be owner occupied.
Here is an excellent video that explains exactly what a reverse mortgage is and how they work:
The video explains everything you need to know about these kind of loans, along with a review of the changes that have taken place over the last few years. Specific financing comparisons are given. After you have read the article come back and take a look at the video.
Keep reading below to learn both the advantages and disadvantages of a reverse mortgage.
Types of Reverse Mortgages
There are essentially three types of reverse mortgages that seniors can take advantage of. Here is a description of each of these reverse mortgage options:
Single-purpose reverse mortgages. A single purpose reverse mortgage is a loan product that is offered by some state and local government agencies as well as nonprofit organizations. These types of mortgages are primarily for low to moderate income borrowers. These type of reverse mortgages are not available everywhere and can be used only for home repairs, improvements, or property taxes.
Federally insured reverse mortgages. These type of reverse mortgages are known as Home Equity Conversion Mortgages or (HECMs) for short, they are backed by the U.S. Department of Housing and Urban Development (HUD). This type of reverse mortgage is the most common and also the most expensive. They also tend to be the most widely available reverse mortgage option with no income or medical requirements. They can be used for any purpose.
Proprietary reverse mortgages. A proprietary reverse mortgage is a private loan that is backed by the companies that provide them.
Before getting any kind of loan borrowers should understand how to get the best mortgage interest rates. Over the life of the loan this can make a huge difference in what you actually pay. Keep in mind you want to not only look at the rate but all the terms that go with it.
Reverse Mortgages – Advantages & Disadvantages
Pros of Reverse Mortgages
Here are the advantages of a reverse mortgage for seniors worth considering:
They provide you with income – A reverse mortgage is a loan that is given based on your age, the value of your home and the current interest rates. If you have a lot of equity in your home, the reveres mortgage can provide you with a good amount of money. When you get a reverse mortgage, you have the option of getting your money in the form of regular monthly payments or as a lump sum. You can then use the money to pay for your expenses or for anything else you choose to spend it on.
In most cases they do not conflict with your Social Security or Medicare payments – In most cases the money from your reverse mortgage does not cause any problems with your benefits like Social Security. Of course, you should always check beforehand to verify that there will be no issues. Read more on how reverse mortgages can impact medicaid.
You could use the money to buy a smaller home – If you are a senior and you are looking to move into a smaller home that is easier to care for – and less expensive – you could potentially use the money from your reverse mortgage to buy a different home. Consult with a real estate agent and financial adviser before attempting this, though. You want to be sure that it is a smart financial move.
The money is tax-free in most cases – In most cases you can get the money from your reverse mortgage without paying taxes on it. Again, make a point of talking with a tax professional before you make any assumptions, as your specific circumstances may result in tax issues that you are not aware of.
You shouldn’t have to worry about owing more on your reverse mortgage than the home is worth at the time of sale. There is typically a “non recourse” clause in the agreement for your reverse mortgage that protects you or your estate from owing money beyond the value of the home when the loan is paid off. Many people worry about taking out a reverse mortgage and then winding up in a situation where their heirs have to pay off the loan. Fortunately, this is not an issue, as long as your heirs do not want to get the home after you pass away. Just make sure that the clause is there before you agree to borrow the money.
Your spouse will not be forced to pay off the reverse mortgage loan upon your death – Up until 2013, many reverse mortgage lenders would require that the surviving spouse of the borrower repay the loan when the borrower passed away. There were HUD policies in place which allowed lenders to behave this way, leading many widows and widowers to wind up in impossible situations – ultimately into foreclosure. It was such a problem that a legal case was heard on the issue by a federal court in Washington, D.C. The court struck down the HUD policies and from that point onward lenders no longer attempted to collect from widows and widowers.
Cons of a Reverse Mortgages
Here are the disadvantages of a reverse mortgage worth considering:
Your heirs can’t keep the home without paying off the loan – If you want to leave your home to your children or other heirs, it is best to find a different option than a reverse mortgage for meeting your financial needs. Unless your heirs pay back the loan, they will not be able to keep the house. In most every situation where a reverse mortgage is used, the end result is that the equity in the home decreases. The situation can be unfortunate if you had hoped to leave your heirs as much as you could.
A lot of reverse mortgages are adjustable rate loans – Adjustable rate loans mean that the interest rate on the loan can change over the course of the loan. Adjustable rate loans can wind up being much, much more expensive than originally anticipated should the rate go up by a large amount. If you want to avoid this pitfall you will need to hunt down a reverse mortgage product that does not have an adjustable rate, which may be hard to do. With fixed rate mortgages being so attractive this could be a situation where you end up paying too much for a mortgage.
It is possible to live longer than the equity in your home – Reverse mortgages are usually best for older seniors, because if you live long enough you can find yourself in a bad situation – where the equity in your home is gone, but you still need living expenses that you can no longer get from the reverse mortgage. A reverse mortgage should be part of an overall plan for supporting yourself in your final years, not an easy solution to fill in your income before you figure something else out. Make sure you have a complete understanding of your financial before committing to a reverse mortgage. I cannot emphasize this enough – If need be meet with a qualified financial planner who can detail potential financial circumstances you may face.
Application fees for reverse mortgages can be costly – The fees associated with a reverse mortgage can be expensive, including higher than average closing costs and a high origination fee. Fees may include private mortgage insurance fees, appraisal fees and title insurance fees. Unlike a more standard loan product, the fees that come with a reverse mortgage can be high enough to eat into the value of your home by one or more percentage points.
Moving out of your home results in the loan coming due – If you run into a situation where you or your spouse (co-borrower) do not live in house for a period of a year or more, then the loan company can come knocking for the full amount of the loan. If you anticipate any major health problems, where you may not be living in your house for an extended period of time, a reverse mortgage may not be the best choice. You may find yourself in a full-time care facility for medical care and at the same time have to deal with the lender asking for you to pay the entire loan in full.
Watch For Reverse Mortgage Scams
High on the list of people who are often preyed upon by scammers are senior citizens. There are a lot of sleazy companies out there who will do whatever they can to make others make bad financial decisions. The reverse loan mortgage arena is certainly a place where this can happen. From late night infomercials to letters in the mail, seniors are often baited into things that don’t make a lot of sense. Consumerist has reported on reverse mortgage scams in the past where companies were sending deceptive mailings to seniors.
More than 10,000 consumers received reverse mortgage solicitations from a company called New View that were allegedly made to look like official government notices from the Federal Housing Administration.
The envelopes in which the documents were sent included labeling which said “Economic Stimulus Notice” and “Government Lending Division,” while the body of the solicitation identified the sender as “Federal Housing Administration Home Benefit HECM Program.” These of course were not federal programs but were made to look that way to deceive people.
This is just one example of the type of scams that can occur within the world of reverse mortgages. What seniors need to keep in mind is that if something looks too good to be true it usually is!
Work With A Financial Adviser To Determine If A Reverse Mortgage Is Right For You
If you are considering a reverse mortgage, it is worth your time to seek out a reputable financial adviser that specializes in helping seniors to discuss your situation. Seek out an adviser that is not associated with any lenders and is not trying to sell any products. They will cost a bit more, but will not have the conflict of interest and will be more trustworthy.
Once you have a good adviser, you can work with him or her to determine if a reverse mortgage would be useful and beneficial to you as part of an overall financial plan for your later years. Remember, reverse mortgages are just one financial tool that can be beneficial, or not, depending on your circumstances. Weigh the pros and cons, talk to an adviser and create a plan that will help you achieve your financial goals.