Most people begin to prepare for their retirement many years before it actually comes around. After all, nobody wants to be old, out of work, and without any sort of income or fund to fall back on.
In spite of this, that may end up being the case for any number of reasons. People who are at retirement age may end up finding that they are desperately short of money to live on. If you are in that situation, a reverse mortgage may be just what you need to bail you out.
What is a reverse mortgage? How does it work? How do you know whether or not you are eligible to benefit from it? And if you are, is it right for you? Is it a scam? Many people certainly think so. What are the pros and drawbacks?
These and other questions will be answered by this post, as I try to help you make an informed decision on this financial instrument.
What is Reverse Mortgage?
Let’s say that you are in that circumstance we referred to above. You are 62 years and above, and you realize that money is a very real issue at this point. Maybe you own your own home too, that you make mortgage payments for.
Well then, to help raise some much-needed money to finance your retirement, you may decide to take out a reverse mortgage on that home.
A reverse mortgage is a financial instrument or product that allows you, as a homeowner who is 62 years and above, to take out a loan using your home equity as leverage.
A reverse mortgage might sound a little crazy if you’re hearing about it for the first time. We all know what a mortgage is. With a regular mortgage, you make payments to the mortgage provider for the funds required to own a property.
With reverse payment, you are already the owner of the property. It simply allows you to convert the equity that already exists in your home to money.
And so rather than making payments to the lender as with a regular mortgage, here, the lender makes payments to you. These payments may come all at once in the form of a lump sum, or they may come at regular intervals as agreed.
This is a loan of course. It has to be paid back when you move away from the home, sell it, or pass away.
What would you need a reverse mortgage for? Well, for any number of purposes. It might come in handy to settle pressing medical bills, making investments, helping to fund college fees, supplementing retirement income, or paying back other loans.
Types of Reverse Mortgages
There are three major types of reverse mortgages. The type that you settle on will ultimately depend on which is available for you, your financial and property conditions, and the terms and conditions attached.
Home Equity Conversion Mortgage
This is the most popular type of reverse mortgage. Compared to the other types, it comes with higher upfront costs. The Home equity conversion mortgage is federally insured and is offered by Federal Housing Administration (FHA) approved lenders.
HMEC funds can be used for any purpose, which explains why it is so popular. Additionally, it does not come with any health requirements.
The limit for the HECM loan in 2020 was $765,000.
Proprietary Reverse Mortgage
This type of loan is private in nature and is not backed by the Government. A proprietary reverse mortgage is suitable for homes that are of higher value as such homeowners can access funds of greater value than with HMEC loans.
In general, proprietary reverse mortgage loans are not as tightly regulated as home equity conversion mortgages. Also, they are not federally insured. Relatively, they make up only a small share of the reverse mortgage market.
Single-Purpose Reverse Mortgages
Single-purpose reverse mortgage loans are offered by state and local government agencies and not-for-profit organizations.
As the name implies, this reverse mortgage loan is drawn out for a specific purpose. The financial lender identifies and approves the purpose for the loan and limits the usage of the loan funds to that particular purpose.
For example, a homeowner might take out a single-purpose reverse mortgage loan in order to remodel their property. When the financial lender approves this loan, it will look to confirm that the loan is actually used to work on the property.
The requirements for single-purpose loans are generally easier to meet than those for HMEC loans and proprietary reverse mortgage loans. On the other hand, there are not so many lenders offering these loans in the first place.
How Does a Reverse Mortgage Work?
A reverse mortgage sounds like free money. It sounds too good to be true. After all, you’re taking out a loan that will require repayment unless you move out of your house or die.
We have already discussed how a standard mortgage works. With that type of mortgage, you make regular payments to the lender at regular intervals, say, monthly. As a result, the Debt you owe for taking out the mortgage loan steadily reduces well your home equity steadily increases.
With the reverse mortgage, on the other hand, a financial lender will pay you monthly (or a lump sum) on the equity of your home. What it means is that over time, the debt you owe steadily increases while your home equity steadily reduces.
The amount that you can borrow using a reverse mortgage is known as the principal limit. This amount depends on a variety of factors, such as the mortgage, current market value of the property, associated costs, current interest rates, and the age of the borrower.
The chances of you getting a high principal limit depends on your age, how low current interest rates are, and the value of your property. The older you are, the higher the amount that you can access.
Reverse Mortgage Requirements
A reverse mortgage loan is not available to just anybody who may be interested in it.
To take out this loan, there are certain requirements that the financial lender will demand that are met satisfactorily. These are:
- You must be up to the age of 62, or older.
- The home must be owned primarily by you.
- The home has to be your primary place of residence.
- You must agree to continue paying off the current existing mortgage using the proceeds from the reverse mortgage.
- Property taxes, insurance fees, and other costs must continue to be paid by you.
- Your property must meet up the requirements the financial lender has.
- You must continue to keep the property in good condition, to maintain its value.
Pros and Cons of Reverse Mortgage Loans
Reverse mortgages certainly seem like a sweet deal. They allow you to take out loans against your home equity which frees up funds that may come in handy.
It certainly has a number of upsides. But before making a decision, you must understand that there are also a number of drawbacks to be taken into consideration.
Pros of Reverse Mortgage
First, let’s look at the advantages of reverse mortgages.
1. Reverse Mortgage generates funds for your retirement. Retirement can be a point when frugality becomes an acquired lifestyle. With regular income from work cut off, any extra source of income is usually appreciated.
With expenses piling up, reverse mortgages can be a lifesaver for a homeowner. As long as you primarily reside in that home, you can receive payments that will make your retirement so much easier.
The proceeds that are generated can be used for a myriad of purposes. That is, as long as you do not opt for a single-purpose reverse mortgage. It can help you pay off outstanding loans and debts.
You can pay off your forward mortgage to prevent foreclosure, or you can settle medical bills. You can simply use it as a buffer for your daily expenses.
2. You receive payments instead of making payments. The principal difference between a reverse mortgage and a standard mortgage is that while you make regular payments to service your loan in the latter, you actually receive payments in the former.
Of course, it must be noted that there are certain fees and costs that are expected of you on a monthly basis. These include insurance fees and property taxes.
3. You cannot be forced to repay the loan early. As long as you keep to the terms of the loan, that is.
The principal terms are that you live primarily in the house and you did not sell it off. As long as you are alive, you will continue to receive the arranged payments and will not be pressed to repay the loan.
4. You don’t pay taxes on a reverse mortgage. Even though you may receive reverse mortgage payments on a monthly basis, it is not actually income. As a result, you will not be required by the IRS to pay any taxes on them.
5. You get to remain the legal owner of your home. Drawing up a facility on your home’s equity does not mean that you cease to become the property’s legal owner.
While the loan agreement remains in place and you continue to live in that property, you remain its owner and the title remains in your name.
6. You may choose how to receive the funds. There are options as to how the proceeds of a reverse mortgage are disbursed to you. Usually, the method used depends entirely on your own preference.
You may decide to receive the proceeds as a large lump sum, or it may be broken down into regular payments. You can even decide to open a line of credit on the loan. It all depends on you.
Cons of Reverse Mortgage
On the surface, it is understandable why a reverse mortgage may seem like an attractive offer for a retiree homeowner. But there are several drawbacks to this financial product. Let’s look at them too.
1. To be eligible to qualify, you must be 62 years old or above. Reverse mortgage loans are not available to just anybody. For reverse mortgages for spouses, the youngest borrower must be at least 62.
There are loopholes to bypass this rule. For example, the older spouse may be assigned the deeds of the house. This effectively makes that spouse the only party for the reverse mortgage.
But this loophole comes with potentially negative impacts. It is best to wait or look for other alternatives.
2. Reverse Mortgage Fees and Costs May Be High. There are several fees and costs that come with reverse mortgages. Depending on the type of reverse mortgage or the lender used, these costs may turn out to be on the higher side.
When you take out a reverse mortgage loan, some of the fees you are expected to settle include origination fees, closing costs, insurance, and servicing fees.
When considered all together, these costs may significantly impact the proceeds of the loan that you receive. Failure to pay these fees may lead to your loan being due much sooner than you expected.
3. The loan becomes due for payment if you happen to move out of the house. As long you maintain your house as a primary residence, living in it most of the time, you are in no danger of breaking the terms of agreement of the loan.
It becomes an issue if you are forced to leave your home for an extended period of time. Moving out of state, long-term visits, medical conditions requiring an extended hospital stay, and moving to a nursing home all count as failing on the reverse mortgage conditions.
In any of these cases, you may be forced to sell off the home to repay the reverse mortgage loan. Alternatively, you will be required to look for other sources of cash to offset the loan.
4. Your loan keeps increasing over time. With a reverse mortgage, it is easy to forget that you are in debt because you are receiving payments. But it is important to remember that there is not just a loan, but that it keeps increasing annually.
These loans come with interest. For the duration of that loan, the interest will continue to add up. This is not helped by all the other extra costs that you are required to pay.
5. Reverse mortgage eats away at the equity of your home. This is in stark contrast to forward mortgage. With a regular mortgage, your home equity will continue to increase with every payment that you make.
On the flip side, your home equity is eroded with a reverse mortgage. And the debt that you owe increases.
1. What is reverse mortgage?
A reverse mortgage is a type of loan that allows you to gain access to funds by leveraging on a portion of your home equity. With a reverse mortgage, you retain the title to your home while receiving payments from the financial lender.
2. How do I qualify for a reverse mortgage loan?
To qualify, you must be 62 years of age or older. You must also be the titleholder to your home. For couples, the younger borrower must be at least 62 years old.
Additionally, you must have sufficient equity in your home. You must be financially stable enough to maintain the costs and fees that come with the loan.
3. Do I still own my home?
As long as you live in your home and service the taxes and fees, then the home still belongs to you. The title remains in your name.
4. Should I take a reverse mortgage?
As I mentioned earlier, a reverse mortgage has the makings of free money. It looks like some silly financial lenders have decided to pay you for owning your own property. As if!
There are monumental risks associated with reverse mortgages. More than 18% of reverse mortgage loans taken out from 2009 to 2016 are expected to enter default due to unpaid taxes and insurance, this Washington Post article states. It also lists several other perils associated with reverse mortgages.
But that does not necessarily mean that it is not for you. With sufficient planning and putting all factors into consideration, it may be just what the doctor ordered.
A reverse mortgage can be a liberating financial instrument for elderly homeowners. It helps make much-needed funds available, backed by their home equity. But is it always the right way out?
In this post, I shed light on what reverse equity is, its types, how it works, and the requirements for eligibility. I also examined the benefits that can come with a reverse mortgage, together with the attendant drawbacks.
Should you take out a reverse mortgage? Ultimately, the decision rests on you. But it is very important that you are sufficiently educated on it first, before rushing into any decisions that you may regret later.