One of the most controversial mortgages available is the reverse mortgage. Among the senior homeowner population, there has always been a double-sided debate about these loans.
On one hand, the senior homeowner has earned the equity in their property. Many seniors own their homes free and clear and deserve to relax and live comfortably without financial stress. With fixed incomes, many seniors struggle to make ends meet, often juggling the cost of food, medications, home expenses, and everything else. A reverse mortgage is an excellent way for seniors to supplement their retirement income and alleviate stress.
In opposition to these loans are the senior’s heirs, who stand to inherit the home and other assets when they pass. The children know that unless they can refinance the family home at the payoff event, the lender will get the property. The heirs try to make a reverse mortgage a family decision when it’s really the homeowner’s choice.
This Lender Tribune article will uncover the truth about reverse mortgages so you can make the best decision for your decision for yourself.
Understanding Reverse Mortgages
A reverse mortgage is a way to liquidate your home equity and receive cash payments in return. These loans are only available to people 62 years of age or older. Unlike a normal mortgage, these loans work in reverse.
Think of a normal or forward mortgage where you borrow a sum of money to buy your property. Now simply reverse it, so that the bank makes payments to you, up to the value of the property, with the property acting as collateral.
With a reverse mortgage, the bank pays you for the value of your home as a lump sum, on monthly terms, or as a line of credit for a chosen term or the remainder of your life. As the payments are received, the home equity reduces.
For IRS purposes, a reverse mortgage is considered a loan advance and therefore not taxed. From the lender’s perspective, this is a loan to the homeowner with the property as collateral and the loan becomes due when one of the events occurs:
- The homeowner dies;
- The homeowner moves away; or
- The homeowner sells the property.
Upon the happening of any of these events, the lender has a right to recover the principal, interest, fees, and mortgage insurance from the value of the property. Any proceeds remaining once they have recovered their costs belong to the homeowner or their heirs.
In some cases, the heirs may choose to pay the mortgage payments in order to keep the property. The reverse mortgage is structured in such a manner that the loan amount doesn’t exceed the value of the property so that the estate of the deceased homeowner isn’t liable.
So far, it looks like this type of mortgage is a winner for seniors. But there are some downsides.
Beware of Scams
The Consumer Financial Protection Bureau warns of contractor scams that approach you about a reverse mortgage to pay for repairs to your home, and you always have a three-day right to cancel a reverse mortgage.
What is the Home Equity Conversion Mortgage (HECM)?
This is a government reverse mortgage that you can only get through an FHA-approved lender. These loans have special requirements like counseling and you need to be 62 or older with a large amount of equity in your home.
What are the Costs of a Reverse Mortgage?
Be prepared to pay out some money for the appraisal once you find the home, these are COD or paid in advance for $250 to $1000 depending on your home size, there are origination fees you pay to the lender at the closing, this will get financed so you won’t need to worry about it upfront.
What Are the Downsides to a Reverse Mortgage?
Borrowers ages 62 and over can use a reverse mortgage to liquidate their property for cash. As the payments for the borrower are released by the lender the borrower’s equity stake in the property decreases. Although it is marketed as a way for seniors to release liquidity, it does come with some drawbacks.
The biggest drawback comes in the form of loss of inheritance for the heirs. The loan is repaid by liquidating the property in question usually after the death of the borrower. If funds are left over after paying the principal, interest, and fees then those are handed over to the heirs but if the funds are insufficient then nothing is left over for their heirs.
The disadvantage comes in the form of heirs not receiving their inheritance or possibly not having a house to live in after the borrower dies. In some cases, the heirs can choose to pay the mortgage to keep the property, this however depends on their ability to afford the mortgage.
One of the terms of the reverse mortgage requires the borrowers to live in the mortgaged house as their primary residence. If at any point they vacate their premises for a year, the loan becomes payable.
Similarly, since many seniors take a reverse mortgage to pay medical expenses, they should consider that if they move into a long-term care facility, the loan will become payable. The borrowers are required to furnish in writing that the property in question is their primary residence, so relocating or moving to a nursing facility will trigger the mortgage to become due. When looking at a reverse mortgage as an option, carefully consider these possibilities.
What Happens If I Outlive My Reverse Mortgage?
Sadly, reverse mortgages are one of the most misunderstood financial products available. There are many myths and misconceptions that scare seniors out of using their home as a living source of income.
If you or your spouse live in the house, you cannot outlive your reverse mortgage. The loan does not become due until the last homeowner leaves the home permanently.
It is possible to spend all the money on your line of credit. If that happens, then there is no more cash to draw out, but you still own the house and can live in it for the rest of your life. You will be required to continue to pay the property taxes, homeowner insurance, homeowner association dues (if any), and maintain the home just like all property owners.
Once the home is vacated permanently, the loan becomes due. The homeowner or their heirs must let the servicing company know whether they plan to keep the house or sell it within 90 days. If the house is to be sold, then it must be put on the market. Ninety-day extensions will be granted up to one-year total to sell the house as long as it is actively being marketed.
Previously, regulations allowed for one of the homeowners to be removed from title to qualify the house for a reverse mortgage or a larger reverse mortgage. That created a problem for the homeowner who was removed when the borrower dies or leaves the home first. New regulations now fully protect the non-borrowing spouse.
Why Should You Never Get a Reverse Mortgage?
The main risk is that you can ultimately lose your home. Something we don’t think about as we get older is, we may have to enter a nursing home or retirement home, at this time the loan is due and without the means to refinance the loan, it would effectively leave you homeless. Even though you’ll be getting the income from your reverse mortgage, you’ll have to maintain the home insurance, repairs, and property taxes, this could become too much to handle at some point.
While you are getting these monthly payments or the lump sum payment, the interest is building up. And it could be considered more expensive than a traditional mortgage.
It could affect programs like qualifying for Medicaid, you don’t want to jeopardize your ability to get benefits especially as you age.
How Much Money Do You Get from a Reverse Mortgage?
The amount of money you can get from a reverse mortgage depends on your available equity. You can’t use more than 80% of the available equity and that amount won’t be more than $679,650.
The exact amount you receive from the reverse mortgage depends on many factors including your home value, your age, and the interest rate you qualify for.
You can choose to get those funds in a lump sum monthly payments or the popular option of taking a lump sum upfront to take care of the immediate need and then monthly payments for the duration of the loan, some choose a credit line that they can draw off until the funds run out.
A reverse mortgage is an excellent way to access the equity in your home so you can live more comfortably in retirement. Lower lending limits usually allow there to be equity remaining in your home at the end of the loan, but this largely depends on property values and how long the loan was in place. Your heirs can sell the home when you and your spouse die, pay off the loan, and benefit from the remaining equity. Done properly, everyone benefits.