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Reverse Mortgages
Reverse mortgages are government-regulated loans that require the borrower to be at least 62 years old and a homeowner. The concept is to convert a portion of your equity in your home into cash to be used for any purpose, as long you 1) continue to live in the home, 2) perform necessary home maintenance, and 3) pay your property taxes and homeowners insurance.
"Reverse mortgage" is a somewhat misleading term. With a traditional mortgage, you receive proceeds from the mortgage company to buy something, such as a house or, in the case of a home equity loan, just about anything you want. For this privilege, you pay interest and principal to the mortgage company.
With a reverse mortgage, the fundamentals are essentially the same. You receive proceeds to use as you choose but rather than paying interest and principal to the mortgage company, the interest "accrues" (or adds up) and is collected (along with the principal) by the mortgage company when the house is sold. This would normally occur when you no longer live in the house, that is, when you move in with your kids, enter a senior living center, or die. (I don't mean to be insensitive, but as you read further, you'll realize that I write in a very frank style.)
The term "reverse mortgage" actually comes from the fact that as you pay off a traditional mortgage, you are building equity in your house. Whereas, with a reverse mortgage, you are converting the equity in your house to cash you can use to maintain or improve your lifestyle. You are relinquishing equity in your house as you borrow the cash and interest accrues. It's the reverse mortgage company that is building equity in your house--the reverse of what happens compared with a traditional mortgage.
The good news is that you don't have to make mortgage payments on the amounts you borrow. If you are at least 62 years old and have a substantial amount of equity in your home, you may well be able to generate sufficient extra cash to be able to stay in your house. In the next section, I'll outline some of the things you should consider before deciding to request a reverse mortgage.
What Are The Alternatives?
HOME EQUITY LOAN: If you are spending all of your income (or more) and do not 1) anticipate a significant increase in your income, or 2) anticipate a significant decrease in your expenses, then there is no reason to take out a home equity loan. That is, you won't be able to pay it back. On the other hand, if you need to cover a temporary shortfall, then a home equity loan may be your cheapest option.
PROPERTY TAX RELIEF: Many seniors on fixed incomes are watching their property taxes increase dramatically, sometimes becoming their single largest budget item. Make sure you have applied for all available relief from your local and state governments.
For example, Massachusetts allows municipalities to adopt a program similar in nature to a reverse mortgage where homeowners can defer up to 100% of their property taxes. Like a reverse mortgage, the municipality takes an increasing share of the homeowner's equity via a lien on the property and recovers the accumulated property tax, plus interest, upon sale of the home.
Other communities and states offer tax relief by "freezing" or capping tax bills for senior citizens. Find out what is available in your state and take advantage of these programs. Applying for them is generally very easy and can conserve your cash to the tune of hundreds of dollars per month.
SELLING YOUR HOME (OR PART OF IT): Selling a house and purchasing a smaller, less expensive house or condo can free up cash without adding the complication of taking out a loan or reverse mortgage. If you're up to it, moving to a less expensive part of the country can add to the amount of cash you free up and have the additional benefit of lowering your general living costs (groceries, personal services, etc.)
It may be possible to sell part of your house (that is, an interest in your house) to an investor (usually a child) who, in turn, agrees to establish a life estate for you to remain living in the house for the rest of your life. If this sounds a little complicated, it is. But with a good estate planning attorney working with you, you may well be able to keep your house, have the cash you need for living expenses, and create a mechanism for transferring your house to your heirs outside of probate.
Is A Reverse Mortgage Right For You?
The perfect scenario for a reverse mortgage solution is one in which the borrower has substantial home equity (outright ownership is not necessary) and the proceeds of the reverse mortgage are sufficient to comfortably cover the cash shortfall.
Some people use reverse mortgages to supplement their retirement lifestyles, perhaps using the proceeds to take trips, buy a recreational vehicle, remodel a kitchen or bath, etc. I don't discourage this approach. I just encourage people to take a close look at their financial situation to ensure that they can handle unexpected changes, such as dealing with an illness or stroke.
If you believe that a reverse mortgage is a good option for you, then the next step is to get the details from a reputable company that has qualified people who specialize in originating reverse mortgages. I believe that you'll have a better experience by dealing directly with a lender rather than working with a broker whose interest in you ends with selling your loan to an underwriter.
By law, you are required to speak with a certified reverse mortgage counselor, who can have no ties with the lender. Don't get 90% of the way down the road before having this counseling session. Do it up front and be sure you want to go ahead with the loan. If you feel pressure from the lender, take it as a sign you should slow everything down and reassess where you are. Trust your instincts.
Reverse Mortgage Myths
The mortgage company will own your house. Not true. The mortgage company takes out a lien on your house in order to recover the principal and accrued interest when you stop living in your house. You or your estate retain title (ownership) of the house.
When the equity in your house is used up, your monthly payments stop. Not true. If you elect monthly payments, the amount you receive will continue until you stop living in your house. This is true even if you "use up" all of the equity in your home. See the next myth for why this is true.
Your heirs will inherit a large debt if the house is sold for less than the amount borrowed. Not true. A reverse mortgage is a nonrecourse debt collateralized by your house. That means that the loan will be repaid with the proceeds from the sale of the house. If the house sells for less than the loan balance, the mortgage company recovers the shortfall from the FHA (if FHA insured) or through a private reserve.
If you are at least 62 years old and a homeowner, a reverse mortgage may be the perfect solution to covering a cash shortfall or enhancing your retirement lifestyle.
But don't jump too quick. Reverse mortgage closing costs are high, likely making these mortgages your most expensive option. So spend the time to understand what you're committing to in order to avoid surprises.