Reverse mortgages enable older homeowners to turn a portion of their home equity they have amassed in their properties into tax-free cash via a loan that isn’t required to be repaid until they pass away, sell or move out of their house. This might sound like a good idea to a lot of seniors who are currently navigating the financial fallout of the coronavirus pandemic that might have occurred due to the loss of jobs needed to make ends meet, as well as reduced income from retirement savings because of the volatile stock market.
But while a reverse mortgage could be exactly the right tool at the right time, it also could be a costly mistake. That’s why it’s important to understand exactly how these loans work and to explore alternatives before you commit. Here are some ways to know if a reverse mortgage is right for you.
Benefits
To better understand reverse mortgages, it helps to examine a typical scenario. Let’s take the Smiths, for example, who both are 66 years old and together receive $3,500 per month in Social Security benefits. Their monthly mortgage payment is their heftiest expense. They own a home worth $400,000, with a $492 monthly mortgage payment for principal and interest, and $50,000 remaining on the balance of the loan. The Smiths elect to refinance with a reverse mortgage and choose a loan with an adjustable-rate based on the one-year LIBOR index. Given their age, location, and property value, the Smiths qualify for $222,400 in financing according to the MyHECM reverse mortgage calculator.
The loan results look like this:
- The $50,000 remaining loan balance is paid off, and the Smiths save $492 a month in mortgage payments.
- They also receive a $615 monthly payment for life.
- They now are ahead by $1,107 per month ($492 plus $615).
- Instead of lifetime payments, they might elect to get a $1,512 monthly check for 10 years.
Although that sounds like a great deal, there are drawbacks to the reverse mortgage model that should be considered.
Why reverse mortgages aren’t for everyone
FHA-backed HECMs are only available to those ages 62 and older, and they’re also are costs involved in originating a reverse loan. For instance, the Smiths might pay $8,000 for the up-front mortgage insurance premium, a $4,000 origination fee, and $2,800 in closing costs— for a total of $14,800 in up-front expenses. They also have a 0.5 percent ongoing mortgage insurance fee calculated monthly. Those are big fees folks on a tight budget.
A reverse mortgage can be foreclosed, as well. This may seem odd for a loan with no required payments for principal and interest, but other obligations continue. Borrowers must keep paying taxes, insurance, and HOA fees. If you stop paying those, a reverse mortgage can be foreclosed.
Perhaps most importantly, seen in the long run, reverse mortgage benefits may decline in value because of inflation. Think of the $615 fixed monthly payment received by the Smiths. It will buy a lot less over time as inflation eats away at buying power.
Qualifications
To participate in the FHA reverse mortgage program — by far the most popular — you need to be at least 62 and have plenty of real estate equity.
The largest available FHA reverse mortgage at this time is $765,600 for a single-family home. According to the Consumer Financial Protection Bureau: “Your borrowing limit is called the ‘principal limit.’ It takes into account your age, the interest rate on your loan, and the value of your home. In general, loans with older borrowers, higher-priced homes and lower interest rates will have higher principal limits than loans with younger borrowers, lower-priced homes, and higher interest rates. If you are married or co-borrowing with another person, the principal limit is based on the age of the youngest co-borrower or eligible non-borrowing spouse.”
Paying off a reverse mortgage
A reverse mortgage is a form of debt that grows each month. So, how do you pay it off? First, a reverse mortgage only needs to be repaid when one of these things happens: the property is sold; the borrower moves away, or repayment is due because the borrower has passed away.
If the remaining loan balance is more than the value of the property, an FHA-backed reverse is non-recourse financing. The debt is secured by the value of the home and nothing else. If the value of the property is not sufficient to repay the debt, then the difference is paid by the FHA insurance program.
Alternatives
No mortgage works for every borrower in every situation, so here are some alternatives to consider if a reverse mortgage is not for you because of age or economics:
- Home equity line of credit (HELOC)
This can be an attractive option because such loans generally have small up-front costs. To get a HELOC you need equity plus a lender willing to offer such financing. The catch: With a HELOC, the borrower has to make monthly payments. Lender practices can be another problem. Lenders may no longer offer HELOCs. The reason is that a HELOC is a second lien. Lenders worry that in the COVID-19 economy, home values might fall. That concern makes HELOCs too risky for some lenders.
- Cash-out refinancing
If you have plenty of equity, a cash-out refinance might work. Lenders also might prefer a cash-out refinance because, unlike the typical HELOC, it is a first-lien loan. If home values decrease, that’s the loan lenders want. It gives them the most protection in case of a foreclosure. But, just like a HELOC, a cash-out refinance creates a new and additional monthly cost.
- Downsize and move
You might consider selling your property and buying a smaller or less expensive home for cash. Sellers can sometimes wind up with a mortgage-free property, plus cash in the bank. They also can save even more if they move to a jurisdiction with no state income tax.
