Understanding Reverse Mortgages: Do they make sense for you?
When you see a popular, trusted spokesperson on TV advertising reverse mortgages, does that prompt you to seriously consider taking out a reverse mortgage? If it does, then the ad is working! Before you make this big decision, educate yourself about the types of reverse mortgages available today, and the costs you’ll incur. A reverse mortgage may or may not be the best financial strategy for you.
The difference between a regular mortgage and a reverse mortgage
Reverse mortgages are a complex financial product and difficult for consumers to understand, especially when compared to a traditional or “forward” mortgage. The primary purpose of a forward mortgage is to purchase a home. At the beginning of the mortgage, the borrower typically has little equity in the home, and makes monthly payments to reduce the balance. When a homeowner lives in a home for many years, and pays a traditional mortgage in full, there is no longer a loan balance and the homeowner has substantial equity in the home. If the home is sold before the mortgage is paid in full, the proceeds from the sale of the home are used to pay off the mortgage before the seller receives any proceeds from the sale.
By contrast, a “reverse” mortgage provides access to home equity either in a lump sum or through multiple payments over time to the homeowner. Homeowners could choose a combination of the two, as well. While the balance of a traditional mortgage falls with each payment, in a reverse mortgage, the balance actually increases, as money is paid to the homeowner. Although the loan balance grows over time, the borrower does not repay the loan while living in the home. The loan comes due only when the homeowner moves out of the home, sells it, or dies. It’s important to understand that at the end of a reverse mortgage, the borrower owes a substantial amount and the equity has decreased, possibly substantially.
Even so, a reverse mortgage holder retains ownership of the home all through the life of the reverse mortgage. As a condition of the mortgage, the homeowner must still pay property taxes, buy homeowner’s insurance, and perform regular maintenance and upkeep on the property.
What happens at the end of a reverse mortgage?
One common misconception is that the house must be sold or surrendered to the bank at the end of reverse mortgage. That is not true. If one’s heirs are able to repay the loan with other resources, they may keep the house. Repayment will be the loan balance or 95% of the home’s current appraised value, whichever is less, and typically due within three to 12 months.
Home equity conversion mortgage
The Home Equity Conversion Mortgage (HECM) from the Federal Housing Administration is the most common reverse mortgage product. To be eligible for a HECM loan, a borrower must be at least 62 years old; use their primary home as collateral; have no outstanding federal debt, such as past due income tax, student loans, or HUD-insured loans; and undergo a financial assessment to determine if adequate resources are available to maintain the home.
Potential borrowers are required to receive loan counseling from an approved HECM counselor, who will educate borrowers on the financial implications of a reverse mortgage, both during life and when the borrower moves, sells the home, or dies; alternatives to a HECM; the borrower’s obligations; and costs associated with the reverse mortgage.
Costs can include a loan origination fee; expenses for home appraisal, inspection, and title search; annual loan service fees; monthly interest accruing on the loan balance; and mortgage insurance premiums. The cost of a reverse mortgage may be substantial when compared to the total value of the proceeds from the loan.
When you see that trusted spokesperson on TV enticing you to take out a reverse mortgage, you also need to consider how long you really want to stay in your current home. Is it safe and comfortable? Will it continue to meet your needs as you age? What other housing options do you have?
Source: The information in this article is from the K-State Research and Extension publication Understanding Reverse Mortgages: Do They Make Sense For You? by Martin Seay and Elizabeth Kiss.