Reverse mortgages are gaining in popularity, as many senior citizens stretch for creative ways to maintain their living standards in an era of near zero interest rates on savings instruments. There’s good and bad in regard to reverse mortgages, and you need to consider both sides before applying for one.
How Reverse Mortgages Work
Reverse mortgages are so-called because they reverse the way mortgages traditionally work. Instead of making payments to the mortgage company, the lender makes payments to you. And while receiving monthly payments are an option, you can also take all of your cash in a lump sum, similar to a cash-out refinance. You can also take the loan as a home equity line, allowing you to access it any time you have a need.
Qualifications for a reverse mortgage include:
- Be 62 years of age or older (both borrowers)
- Own the property outright or paid-down a considerable amount
- Occupy the property as your principal residence
- Not be delinquent on any federal debt
- Have financial resources to continue to make timely payment of ongoing property charges such as property taxes, insurance and Homeowner Association fees, etc.
- Participate in a consumer information session given by a HUD- approved HECM counselor
The maximum loan amount if $625,500, but your loan amount will be calculated based on the appraised value of your home, multiplied by a percentage. That percentage will be based on a combination of factors, including your age and the interest rate on the loan, but it will always be some percentage considerably lower than 100% of the property value. However the older you are, the higher the percentage of the property value can be taken in the loan.
There’s one important feature of reverse mortgages that everyone should be aware of before applying for one. Since you are not making monthly payments on the loan, the interest on the loan will be added to the principal each month. Unlike a traditional mortgage, where you make your monthly payment that includes both interest on the loan and at least a small reduction in the principal balance, with a reverse mortgage the amount of the loan increases the longer that it is outstanding.
This is also why loan amounts are larger the older that you are when you apply. Since an older applicant is not expected to live as long as a younger one, the interest accumulation is expected to be smaller. This allows a loan to an older person to be higher, sometimes much higher, than for a younger borrower.
The loan is due when the last borrower dies, or when the borrowers move out of the property into a new primary residence. At that point the mortgage has to be refinanced or paid off, otherwise the lender can foreclose on the property. Fortunately, if the house sells for less than the amount of the loan owed, neither the borrower nor the borrower’s estate will be required to pay the difference.
The Good Side of Reverse Mortgages
Reverse mortgages have become very popular and it’s easy to see why.
It’s a way to get cash that doesn’t require a monthly payment. As mentioned above, with a reverse mortgage, the lender pays you on a monthly basis, rather than you having to make a monthly payment. It’s one of the few ways available to anyone to borrow money without having a monthly payment.
You don’t need to qualify based on income and credit. Since there is no monthly payment, there is no monthly payment to qualify for. That means income is not a factor. It is presumed that obtaining an additional income is your primary reason for applying for the mortgage.
It works best for the oldest borrowers. The older that you are, the better the reverse mortgage works. A reverse mortgage is set up something like an insurance policy – it largely rests on your life expectancy. The shorter your life expectancy is, the larger the loan that you will be granted. This is a built-in factor with reverse mortgages, since the loans accumulate more interest the longer that they are outstanding.
It can provide a retiree with a much needed income supplement. In a time when retirees are earning very little in the way of interest income on their savings, a monthly check from a reverse mortgage could be an important income supplement.
It may be the only way a senior can stay in their home. For many senior homeowners, short on both cash and income, a reverse mortgage is a way to stay in their home without increasing their monthly obligations.
The Bad Side of Reverse Mortgages
There is a darker side of reverse mortgages, and you need to know what they are if you’re considering applying for one.
Equity stripping. Whatever the apparent benefits of a reverse mortgage, it is in essence a cash out refinance. Any time a home is refinanced and the cash is used for a purpose other than the home itself, the refinance is a form of equity stripping. In general, equity stripping is not a good strategy, especially when you consider that one of the fundamental goals of retirement planning should be to own your home free and clear.
You will probably get more money selling the house. Reverse mortgages are limited by various factors, including your age and the value of your property. If you need all the cash that you can get for survival purposes, you’ll get more of it by simply selling your home, rather than taking a reverse mortgage.
What do you do when your equity is all gone and you still need money? Let’s say that you are 75 years old and you take a reverse mortgage for $130,000 – the maximum that you are allowed under the program. But five years later you’re 80 years old, and the cash is all gone. Will you do next to get the cash that you need to survive for the rest of your life?
Leaving less for your heirs. If your home is your primary asset and most of what you hope to leave to your heirs following your death – and it probably is if you are considering a reverse mortgage – a reverse mortgage will substantially reduce the size of your estate, and how much will be left for your heirs.
You will have to pay mortgage insurance. The upfront mortgage insurance premium (MIP) will be between .50% and 2.50% of your loan amount, and will be paid at closing. You will then pay an annual MIP equal to 1.25% of the mortgage balance. The MIP in both forms is insurance the federal government collects to insure your loan against default. This will be in addition to your property tax, homeowner’s insurance, and utility and property maintenance costs.
Loan closing costs. Just as you would have closing costs when taking a new mortgage, you’ll also have them with a reverse mortgage. Program regulations cap them out at $6,000, but that’s still a good chunk of money.
Reverse mortgages are something like a two headed coin, with a good side and a bad side. Proceed with caution if you’re considering applying for one.