What You Need to Know About Reverse Mortgages
Reverse mortgages are becoming popular for older homeowners who want an additional source of income for retirement. For some homeowners it’s a way to help close the gap between living expenses and a fixed income. The money can be used to pay medical bills, make home improvements, or pay unexpected expenses. Plus the money you receive from your reverse mortgage is tax-free.
With a reverse mortgage, you will still own the home. The loan is repaid when you die, sell your home, or when your home is no longer your primary residence. When your home is sold, you or your estate repay the cash you received from the reverse mortgage, plus interest and other fees. Any remaining equity in the home belongs to you or your heirs. While living in the home you still need to pay property taxes and home insurance, however. Unlike a conventional mortgage these costs are not paid out of an escrow account. You are also required to keep the home in good condition and make repairs when necessary.
How Does a Reverse Mortgage Work?
A lender pays you loan proceeds drawn from the equity you’ve built up in your home, provided certain conditions are met. Depending on your lender, you can set up your payment option such as taking a lump sum payment, a line of credit that you can draw on, or regular periodic payments. Unlike a regular mortgage where you have to qualify based on your credit score and income, it’s possible to qualify for a reverse mortgage with no income since you already have equity.
Requirements for a Reverse Mortgage:
- You must be 62 years of age
- Own your home outright OR
- Have a low mortgage balance that can be paid off when the home sells
- You must live in the home
There are three types of reverse mortgages:
- Single-Purpose Reverse Mortgages: This is a smaller loan used for a single purpose, such as paying taxes or making a specific home improvement. It is the least expensive reverse mortgage option. Single-purpose reverse mortgages usually involve only a small portion of home equity. And since they are not federally insured, the mortgage insurance premium doesn’t need to be paid.
- Home Equity Conversion Mortgages (HECMs): This is a federally insured reverse mortgage and the most popular reverse mortgage. You must meet with a counselor from a housing counseling agency and there are additional fees and costs associated with this type of reverse mortgage. However you have more flexibility in terms of what you can spend the money on than with a single-purpose reverse mortgage. With an HECM you also have more options on how payments will be made to you (i.e., one lump sum, monthly installments, etc.)
- Proprietary Reverse Mortgages: These are private loans backed by the lenders that offer them. They provide larger loan amounts than the HECM program, but they are generally the most expensive type of reverse mortgage. If you live in a home worth more than HUD’s home value limit for the HECM program (currently $625,500), you may qualify for a larger loan amount from a proprietary plan than from a HECM.
Is a Reverse Mortgage Right for You?
A reverse mortgage allows you to remain in your home, receive cash payments, and not make any loan payments until the home is sold. And if you don’t plan on having your children or others inherit your home, your only asset is your home, and you don’t want to move, it might be an option for you.
However these loans are very expensive and the amount you owe grows larger every month. The interest on a conventional loan is calculated as simple interest while on a reverse mortgage the interest is calculated as compound interest. Since a reverse mortgage is a loan, you are going to have loan-related fees which can really add up.
In order to avoid making payments on the reverse mortgage, you have to be living most of the time in your primary residence. If you haven’t lived in the home for a year, such as if you enter a long-term care facility, you have to start repaying your reverse mortgage.
What Are the Alternatives to Reverse Mortgages?
If you have other financial resources that could cover the monthly payments and interest, you could take out a home equity loan rather than a reverse mortgage loan. You could also sell your home and use the money buy a smaller home, rent, or move into another form of housing such as subsidized housing or an assisted living residence.
If you are considering a reverse mortgage, just like with a regular mortgage, it’s a good idea to shop around for the best deal. Servicing and origination fees, which vary from lender to lender, may be negotiable.