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A reverse mortgage can seem tempting if you’re retired and struggling with the costs of a fixed income. However, a reverse mortgage may turn out to be less attractive upon closer inspection.
Not only are there a number of cases of reverse mortgage fraud, but lenders can also charge high fees and close deals, and borrowers must pay for mortgage insurance. Reverse mortgages can also have variable interest rates, so your overall costs may rise in the future.
If you believe that a reverse mortgage can help you stay in your home until you retire, make sure you understand the risks and rewards so that you can make a more informed decision.
What is a reverse mortgage?
BUT reverse mortgage is a lending option that allows homeowners who have paid off all or most of their mortgage to use their own equity. Reverse mortgage funds, which are only available for mainstream housing and generally for people over the age of 62, are structured as lump sums or lines of credit that can be accessed as needed.
In a reverse mortgage, the eligible homeowner borrows money against the home equity collateral. Interest is charged on a monthly basis and there is no need to repay the loan until you move or pass away. Instead, the accrued interest is added to the loan balance, so the amount increases every month.
If the homeowner moves out before the loan is paid, there is a one-year window to close the loan. If the borrower dies, the estate (or heir to the estate) must repay the loan, but no more than the value of the house.
There are three types of reverse mortgages:
- Single Purpose Reverse Mortgage… These reverse mortgages are offered by state, local and non-profit agencies. They must be used to pay for a specific item approved by the lender. This is usually the most affordable form of reverse mortgage.
- Housing to Mortgage Conversion (HECM)… HECM is a reverse mortgage insured by the US Department of Housing and Urban Development (HUD). This is the most popular type of reverse mortgage as it does not require income or medical requirements from the borrower. Moreover, borrowed funds can be used for any purpose, and there are several payment options.
- Own reverse mortgage… Own reverse mortgages are for higher value homes. They are not federally insured and therefore do not charge upfront or monthly mortgage insurance premiums.
Reverse mortgages often come with high commissions and closing costs, as well as potentially expensive mortgage insurance premiums. For loans equal to 60% or less of the appraised value of the home, this premium is usually 0.5%. However, if the reverse mortgage exceeds 60% of the value of the home, the premium can increase up to 2.5% of the loan amount.
Good versus. Bad reverse mortgage
While a reverse mortgage may seem like a good way to access cash in your golden years, it is important to understand the realities of this type of loan. Here’s how you can expect to benefit from a reverse mortgage and what to look for when comparing this loan option with other alternatives.
If you are concerned about your ability to cover living expenses or otherwise meet financial obligations, a reverse mortgage can provide you with the liferaft you need.
- A homeowner who would otherwise have to downsize can use a reverse mortgage to stay in their home.
- The proceeds from the loan can be used to pay off your existing mortgage in full, thus freeing up funds for living expenses.
- Borrowers who comply with the loan conditions are not required to make payments until they either move from home or die.
- Unlike retirement income from 401 (k) s and IRAs, money received through a reverse mortgage is not considered income by the IRS and is therefore not taxable.
- If the value of your home falls below the outstanding balance on the mortgage, your heirs will only have to pay the value of your home, not all of the outstanding debt.
- Many reverse mortgages do not require income or credit.
However, for many homeowners, the disadvantages of a reverse mortgage outweigh the benefits. Consider these risks before taking out a reverse mortgage against your home.
- There are a number of reverse mortgage scams that target older people who need cash to cover their living expenses.
- A reverse mortgage involves additional costs, including registration fees and mortgage insurance up to 2.5% of the appraised value of the home.
- Most interest rates are variable, which means they can increase over time and further increase the cost of borrowing.
- Borrowers owe more over time because interest is charged on the increasing balance of the loan, not on the loan that is paid over time.
- Unlike traditional mortgage payments, interest payments on reverse mortgages are not tax deductible.
- A reverse mortgage can reduce your stake in your home and therefore your family’s inheritance from your property.
- Reverse mortgage lenders may require borrowers to meet strict home maintenance requirements to protect the property’s resale value.
- If you do not comply with any of the loan terms — you don’t pay property tax, don’t take proper care of your home, etc. — you may have to pay off your mortgage ahead of schedule.
- Likewise, failure to comply with the terms of a reverse mortgage can lead to default and even foreclosure.
- Reverse mortgage funds can affect eligibility for need-based retirement income such as Medicaid and Supplemental Security Income (SSI).
Is a reverse mortgage right for me?
In most cases, a reverse mortgage is not the best option for older homeowners. But if the costs are low and you are looking for options, here are the times when you shouldn’t use a reverse mortgage:
- You are planning to move in the next few years… Reverse mortgages are non-repayable unless the homeowner sells the house, changes their primary residence, or dies. This includes moving to a nursing facility for more than 12 consecutive months. So, if you are planning to move in the next few years, a reverse mortgage is probably not the best option. Selling a home with a reverse mortgage also more difficult than selling a house with traditional finance.
- You intend to leave the house to your heirs… Because they are often associated with high fees – and interest is charged on the increasing loan balance – reverse mortgages are an expensive way to borrow money. These additional costs can reduce your net worth and reduce your family’s inheritance if you die. What’s more, if you are planning to transfer your home to a specific family member, a reverse mortgage can complicate the process.
- Friends, relatives, or other roommates live with you… If you die, your home will be sold, so the reverse mortgage can be paid off by your estate. If you have friends, family, or other roommates who stay in your home, they may have to leave the property.
- You cannot cover the costs… Reverse mortgages charge higher fees than most traditional loans, and borrowers also face mortgage insurance costs of up to 2.5% of the value of the home. What’s more, most reverse mortgage terms require borrowers to not pay property taxes, homeowner’s insurance, and maintenance costs in order to avoid default. If there is a possibility that you will not be able to repay the loan, a reverse mortgage is not suitable.
Other mortgage options
If a reverse mortgage isn’t attractive but you still need access to cash, consider alternatives to reverse mortgages– for example, refinancing a mortgage or obtaining a loan secured by equity capital. Check out these other mortgage options before burdening yourself with a reverse mortgage.
Reduce the size of your home
While downsizing may not be an attractive option for everyone, selling a home and buying a less expensive and smaller home can provide additional money to cover living expenses. If the real estate market in your area is hot, this can be a great way to get the most out of your hard-earned home equity.
However, if you are in seller’s market you may have to pay more for the new smaller space. Even so, maintaining home equity without a reverse mortgage can be a much more attractive and less costly way to cover retirement costs.
Cashing out mortgage refinancing
If you have equity in your home but don’t like a reverse mortgage, mortgage refinancing – a great way to borrow against this capital. This process includes obtaining a new home loan to pay off your existing mortgage, while you can also get access to lower interest rates and better loan terms.
If you refinance with a cash advance, you can borrow more than your outstanding mortgage balance and use that funds to cover the cost of home renovations or consolidate other debts. Just keep in mind that you will have to pay a refinancing fee, which is usually between 3% and 6% of the outstanding balance of the original mortgage loan.
Equity loan or line of credit
BUT equity loan – This is the second mortgage, secured by the borrower’s own capital and paid in a lump sum. Likewise equity line of credit—Or HELOC — Allows homeowners to borrow against their capital up to a certain limit and access these funds as needed. This means that you only pay interest on your current balance, not a one-time loan.
Unlike a reverse mortgage, you will have to make monthly payments and lenders will assess your income and credit as they review your application.