A Closer Look At Reverse Mortgages
A reverse mortgage according to Hud.Gov, “is a special type of home loan that lets you convert a portion of the equity in your home into cash. The equity that you built up over years of making mortgage payments can be paid to you.
“When a man retires, his wife gets twice the husband but only half the income.”—Chi Chi Rodriguez, Professional Golfer
However, unlike a traditional home equity loan or second mortgage, HECM borrowers do not have to repay the HECM loan until the borrowers no longer use the home as their principal residence or fail to meet the obligations of the mortgage.”
In addition, “You can also use a HECM to purchase a primary residence if you are able to use cash on hand to pay the difference between the HECM proceeds and the sales price plus closing costs for the property you are purchasing.”
How Does a Reverse Mortgage Work?
“With the baby boomer generation moving into retirement, we are ill-prepared as a society to provide housing alternatives and resources for this 30 million-plus population, who in large part, want to stay put in their current homes.”—John Button, Reverse Vision CEO
Like a traditional mortgage or home equity loan, a reverse mortgage is a loan from a lender that allows for a homeowner to use their home as collateral. With the traditional mortgage, the borrower uses income to pay debt, but with a reverse mortgage, the borrower has a loan balance that grows over time because the borrower is not paying monthly payments on the mortgage.
Typically, a reverse mortgage does not require repayment until the borrower has passed or moved out of the property, meaning your credit score doesn’t hold as much weight. With this in mind, life expectancy is actually a factor when determining the calculation and amount that can be borrowed. Basically, the older the borrower, the more equity available, so the mortgage loan balance will be lower and the more money that will be available.
Case Study: Mr. and Mrs. Smith’s Retirement
Here’s the deal
On a Reverse Mortgage Website, we are given the following example: John and Anne, a retired couple, are 72 and 68. They want to stay in their home, but they need more money each month to pay for their ongoing expenses. In addition, they plan to take a vacation to celebrate their marriage and their retirement.
To answer their question, “How does reverse mortgage work?” a friend suggests a asking a reverse mortgage specialist, but they are skeptical. They don’t know the details so they decide to meet with an advisor to go over their goals and needs. After meeting with their advisor, they learn the current value of their home is $300,000 and they still owe $35,000 on their mortgage. The following chart details their loan:
|Less Current Mortgage||$35,000|
|Cash (Net Proceeds)||$151,600|
|Home Renovation (need)||$20,000|
|Savings for Unexpected Expenses||$125,600|
In addition, the Reverse Mortgage site adds, “The funds available to the borrower may be restricted for the first 12 months after loan closing, due to HECM reverse mortgage requirements. In addition, the borrower may need to set aside additional funds from the loan proceeds to pay for taxes and insurance.”
Reverse Mortgage Skepticism
“If you don’t have a reverse mortgage and don’t know anyone who does, your familiarity with the product probably comes from television commercials.”—Ron Lieber, The New York Times
When it comes to money, it’s always best to weigh the pros and cons. This is especially true in regards to retirement. In recent years, the plan to acquire a reverse mortgage seems ideal for those retirees who have been experiencing ‘more month than money’ in our current economic situation.
Getting access to your home’s equity seems like a no-brainer. The bank allows for borrowers to earn off of their mortgage as a secondary source of income. It’s a solid thought, but not necessarily ideal in every situation. Below, US News’ Money Department provides a few reasons to reconsider a reverse mortgage.
First of all, the fees are generally quite high with a reverse mortgage.
As a loan, a reverse mortgage has fees related to a regular loan and they are often high, perhaps because a credit check is less significant when equity is involved. Because credit scores and income aren’t a factor, this can cause lender risks, so the fees are a way to check and balance reverse mortgages in a business sense.
In addition to high fees, interest rates are also on the higher side. These rates are higher than rates on a traditional home equity loan, for example. With up-front fees and potentially high interest charges, the “large” amount of money that is meant to be acquired is actually quite a bit smaller after everyone gets their cut. While it’s your equity, the bank makes sure to get a big piece of it in this exchange.
Not only does the reverse mortgage affect the individual (or couple), but it will also affect the heirs. Essentially, the loans aren’t expected to be paid off with a reverse mortgage. After the borrower passes away, the home will then be sold to cover the borrowed amount. As such, heirs who would normally receive the home as inheritance will lose all or most of the money from the sale of the home.
For borrowers who move, repayment is necessary. This can happen due to unexpected instances and then the reverse mortgage will need to be repaid. In the eyes of the lender, if the borrower hasn’t been home in a year, then they are considered “moved out.” This, unfortunately, includes long-term illnesses where a borrower is forced to stay in a long-term care facility due to health reasons.
Finally, the home costs are still due. This includes things like property taxes, homeowners insurance, and other maintenance issues that may arise, such as roofing or a new water heater, which may occur every decade or so. With enough equity, these expenses can be covered with the loan, but that simply brings all of the numbers—fee and interest—to an increased amount.
Reverse Mortgage Calculator
“Reverse mortgages, once viewed as loans of a last resort, are slowly gaining some mainstream respect.”—Sarah O’Brien, CNBC
Websites such as Reverse Mortgage provide step-by-step Reverse Mortgage Calculators to determine what amount may be offered for a borrower. These devices will ask questions, such as:
What is your home’s zip code?
What is your birthdate?
What is your spouse’s birthdate?
What is your home’s value?
These factors will help the database determine your and your spouse’s probable life expectancy (birthdate), the value of your home, and the area, which may provide information on typical reverse mortgages in the area. In addition to the basics, other questions may include the following:
Any mortgages and tax liens on the home?
What monthly payments are still due on the home?
How much upfront cash do you hope to receive?
What repairs (maintenance) may arise in the near future?
Do you desire a line of credit? If so, what amount?
These calculators will often give a warning afterwards as they are generic and not specific, so it’s important to speak with an advisor or lender to find out the exact numbers. Lenders, overall, may offer different options on different interest rates and fees, as each individual scenario is different.
Reverse Mortgage Solutions
“Your investment portfolio will work better if you can cut down how much you have to rely on it monthly to live. So a reverse mortgage can really help another asset.”—Tom Davison, Summit Financial Strategies
In an article on Forbes, contributor Jamie Hopkins admits that a reverse mortgage may be a retiree’s “saving grace.” He writes, “According to the Employee Benefit Research Institute (EBRI), Americans are vastly unprepared for retirement to the tune of roughly $4.13 trillion.” In addition, “EBRI projects that the retirement savings shortfall would be much worse if Social Security benefits are reduced.”
Since Social Security is still the largest retirement income asset for most Americans, these issues are staggering for retirees. In addition to their savings, approximately 50 percent of their income comes from Social Security, so if those numbers are lower than needed, a reverse mortgage may be the best option.
Home equity, in addition to Social Security, is another major wealth source for Americans, especially of those within retirement age. In fact, home equity is often overlooked, so a reverse mortgage is somewhat of a hidden solution that has recently come to the surface.
Reverse mortgages, such as the government-insured Home Equity Conversion Mortgage (HECM), supports retirement-age homeowners. The HECM is a reverse mortgage program that allows for borrowers to withdraw on the equity of their home. The plan is meant to be safe as it allows for the elderly a secure method to supplement their Social Security, especially if money is needed for medical.
In a general sense, “The lack of focus on home equity in retirement income planning is nothing short of a complete failure to properly plan and utilize all available retirement assets,” writes Hopkins. “This need to change immediately because strategic uses of home equity, especially reverse mortgages, could save many people from financial failure in retirement.”
The HECM Payment Options
Consumer Information describes the following options for HECM payment methods:
- Single disbursement option – this is only available with a fixed rate loan, and typically offers less money than other HECM options.
- “Term” option – fixed monthly cash advances for a specific time.
- “Tenure” option – fixed monthly cash advances for as long as you live in your home.
- Line of credit – this lets you draw down the loan proceeds at any time, in amounts you choose, until you have used up the line of credit. This option limits the amount of interest imposed on your loan, because you owe interest on the credit that you are using.
- Combination of monthly payments and a line of credit.
The American Dream, Revisited
If owning a home is the American Dream, then being able to live in it after retirement in a tough economy is the new American Dream. While homeownership is at an all-time low, those Americans who still own, also still carry that pride that has existed for decades in the States.
New York Life admits that an increasing number of homeowners are confident that wealth can be built in America, and part of that mindset comes from owning a home. Despite that housing has been on the decline in recent years, and homes generally move along with inflation, this shouldn’t defer individuals from buying.
Homeowners see more wealth than those who rent. However, home equity is seen as a bad investment as the returns are low and inflation is not steady. The reason home ownership is still positive because it can help retirement income, but only when the homeowner has a specific plan of how long they plan to live in the home.
For those who plan their lifestyle according, or to the best of their ability, then it’s time to determine how to afford housing. One can use their home equity by either selling their home to downsize, acquiring a roommate (or living with family), using a home equity loan, or securing a reverse mortgage, to name a few.
Many getting ready to retire, or already in retirement, downsize – less upkeep, taxes and insurance.In addition, certain states have their own special purpose loans, so speaking with an advisor may be a positive option after initial research has begun.
Recap: Reverse Mortgage Pros and Cons
Like any financial decision, there are pros and cons to reverse mortgages. The pros may outweigh the cons, but everyone’s situation is different. Let’s recap briefly:
—Flexible disbursement plans, such as monthly or credit line
—Interest rates may be lower than other options, like credit cards
—The plan eliminates the current mortgage
—Heirs will not be responsible to payoff balances greater than the home
—Proceeds are tax-free (although there are other fees)
—Homeowner can remain in their home without monthly mortgage payments
—Fees and interest rates are often quite high, so it’s meant as a last resort
—It’s possible the value of the inheritance will increase over time for heirs
—Government-based programs like Medicaid may be affected
—Overall, reverse mortgages are complicated so seek help by an advisor
While possible high costs are an issue, for those who require additional monthly income, a reverse mortgage may be the best option. Take some time, read and re-read information, and then always seek a professional to decide if this is best option for you.
As if that’s not enough:
But wait there’s more:
Chris Hogan, Retirement Expert explains why a reverse mortgage is a BAD idea: