WTF Is a Reverse Mortgage?
If you watch late-night television, there’s a strong chance you’ve seen ads with Hollywood B-listers touting reverse mortgages as the new wonder tool for home-owning retirees who need to increase their cash flow.
At first glance, reverse mortgages look practical. These specials loans allow seniors 62 or older to tap the home equity in their primary residence via a lump sum of money, a line of credit, or a stream of monthly payments.
Millions of Americans use reverse mortgages, which offer a special appeal to those seniors who haven’t saved enough for retirement. Qualifying is simple, and you don’t pay taxes on the loan. But these loans can be dangerous for seniors who fail to read and follow the fine print. These complex loans carry several disadvantages, and many individuals have lost their homes due to fraud, as well as their own mistakes.
What Is a Reverse Mortgage and How Does It Work?
The name speaks for itself. A reverse mortgage is the opposite of a traditional mortgage or loan in which you borrow a few hundred thousand dollars from a bank, credit union, or other lender and then slowly pay back the principal plus interest for years (usuallydecades).
With a reverse mortgage, the lender pays you — basically an advance payment on your home equity. Lenders earn a profit through origination fees, mortgage insurance, and interest on the loan balance.
To qualify, most borrowers need about 60 percent equity in their homes. Those approved need no longer make monthly mortgage payments. They can stay in their homes — until death in many cases — as long as they keep paying the property taxes and insurance premiums. They must also keep the house in good repair. And they get to keep the title to the home.
When the borrower dies, sells the home, or moves out, the reverse mortgage loan must be repaid in full.
That means selling the home to raise the money to repay the loan. If you’re still alive and married, you and your spouse must do the selling. If you’re dead, the responsibility falls to your estate (and widow). However, it’s not uncommon for a surviving spouse to remain in the house.
Why Not All Reverse Mortgages Are the Same
There are three types of reverse mortgages, and seniors should choose the one that best suits their needs.
Single-purpose reverse mortgages are the cheapest and easiest to understand. Some state and local government agencies as well as non-profits offer these. And as the name states, these loans can be used for only one purpose like home improvement and repairs or to pay property taxes.
The second type is a proprietary reverse mortgage, which is a private loan that offers the biggest advance.
The third option is Uncle Sam. The U.S. Department of Housing and Urban Development backs reverse mortgages called Home Equity Conversion Mortgages. These federally insured loans administered by the Federal Housing Administration can be used for any purpose.
The Difference Between Mortgages and Home Equity Loans
When considering the benefits of reverse mortgages, it’s best to compare them with a home equity loan or home equity line of credit (HELOC). These products are similar in that they allow older homeowners who are short on cash to access their homes for income through either a fixed-rate loan, a variable-rate loan, or a line of credit. Like reverse mortgages, borrowers are charged interest on the loan balance. The interest paid on a home-equity loan is not tax deductible, but interest paid on a reverse mortgage is.
But the biggest difference favoring reverse mortgages is that they require no monthly payments.
Other benefits: Seniors with low credit scores and high debt-to-income ratios will have trouble getting a home equity loan or HELOC, but not a reverse mortgage. Qualification is easier, and you have the flexibility to change the way you receive the funds. Maybe turn monthly payments into a line of credit? And you’ll never be denied access to your funds if you follow the rules and pay your property taxes.
The Drawback of Reverse Mortgage vs. Home Equity
Remember that, just like a regular mortgage, a reverse mortgage has closing costs such as origination fees, an appraisal, title insurance, and home inspection. Such expenses can add up to more than $15,000. That’s a big sum to pay up front to access your home equity. Home equity loans and HELOCs carry much lower closings costs. Plus, you can get a much bigger loan with less equity in your home.
The Other Disadvantages of Reverse Mortgages
Anyone considering a reverse mortgage needs to understand that even though you’re getting a stream of income, the loan balance is incurring monthly interest charges that grow as the interest adds up over time.
In addition, the loan balance is slapped up even higher with annual mortgage insurance premiums.
There are also other concerns that should prompt seniors who are married with kids to think long and hard before pulling the trigger.
Lenders can and will foreclose on those who stop using their homes as primary residences for more than 12 months. Foreclosure looms for those who don’t keep up with their property taxes, insurance, and homeowners-association dues. And failing to maintain the house can doom a borrower, too.
Family members of borrowers who stay in their homes until they die won’t get the house. The lender will sell the property to recoup the money that was loaned (with interest and insurance). Any profit leftover goes to the heirs.
Not all is lost, though. Heirs can pay off the loan balance to take ownership of the house. The one saving grace is that most, if not all, reverse mortgages stipulate that heirs won’t be billed if the loan balance is bigger than the home’s appraised value.
The rules here are a bit crazy when it comes to a spouse who signs his or her name on the reverse mortgage and later dies. If the surviving spouse is under 62, he or she can remain in the house, but can’t access the outstanding loan balance and must adhere to the loan requirements such as taxes, insurance, and property upkeep. This sounds like a delayed plan for foreclosure.
Reverse Mortgages Can Work When Done Right
Warts and all, reverse mortgages could come in handy for cash-strapped seniors who have done their homework and know exactly what they’re getting into. Those who take the loans need the supplemental income to pay for health emergencies, crucial home repairs, or unexpected property-tax hikes. Reverse mortgages seem ideal for those who don’t have kids or any plans to move for the rest of their lives.
That said, any senior interested in getting one needs to undergo housing counseling and be aware of the predatory lenders that aggressively target vulnerable seniors who could never afford to take out a reverse mortgage in the first place, but end up doing so without understanding the risks that eventually lead to a loan default. Reverse mortgages, like any other financial product, have their place when done correctly for the right customers.