If you are a homeowner in or near retirement age, you have likely seen many television commercials or heard advertisements on the radio about reverse mortgages. These loans can sound very appealing, especially when most of your net worth is tied up in your home. But there are also some drawbacks.
Once you have thought about this type of loan, the first thing you should do is make sure that you weigh all the pros and cons of a loan reverse mortgage first.
What is a reverse mortgage?
If you are an owner who is 62 or over you can borrow against your equity Get cash or a line of credit from a lender. However, unlike a regular mortgage, you don’t have to make monthly loan payments. You will repay the loan if you or your heirs sell the house.
The most common type of reverse mortgage is the HECM (Home Equity Conversion Mortgage). These loans are covered by the Federal Housing Administration (FHA); Borrowers pay an insurance premium to participate, which is used to fund FHA reserves. If a borrower fails to repay their loan, these provisions are used to repay the lender.
In addition to being at least 62 years of age, there are a few other requirements to get an HECM:
- You must own the home in full or have paid back a significant portion of the mortgage.
- The property must be your primary residence and you cannot default on any federal debt.
- They are subject to a credit check and other admission requirements.
- You need to keep up to date on property taxes, insurance, and everyone else Homeowner Association (HOA) fees.
If you are approved for a reverse mortgage, you will need to attend an information session from an approved HECM advisor.
How Reverse Mortgages Work
You are probably wondering how it is possible to get a mortgage with no payments. Usually when you take out a mortgage loan, the bank gives you a lump sum that you pay back over time with interest. At the end of the term, the loan is repaid to $ 0.
A reverse mortgage works in reverse. The lender actually pays you: you can choose to receive a lump sum, monthly payments, a line of credit, or a combination of these options.
The interest and fees associated with the loan are added to the balance each month. That means that the amount you owe grows over time as your home equity decreases. You can keep the title at home all the time, and the balance won’t be due until you move out or die.
When that time comes, the proceeds from the home sale will be used to pay off the debt. If there is equity left, it goes to the property. If not, or if the loan is actually worth more than the house, the heirs do not have to pay the difference. Heirs can also choose to repay the reverse mortgage or refinance if they want to keep the property.
Reverse Mortgage Pros
If you’re struggling to meet your financial obligations, a reverse mortgage can help you stay afloat. Here are some advantages to opting for a reverse mortgage.
1. Helps you secure your retirement
Reverse mortgages are ideal for retirees who are not saving or investing a lot of money but who have a lot of wealth in their homes. With a reverse mortgage, you can turn an otherwise illiquid asset into cash that you can use to cover your retirement expenses.
2. You can stay in your house
Instead of having to sell your home to liquidate your assets, you can keep the property and still make money out of it. This means you don’t have to worry about downgrading or being priced out of your neighborhood if you have to move.
3. You pay off your existing home loan
There is no need to repay your home to take out a reverse mortgage. In fact, you can use the proceeds of a reverse mortgage to pay off an existing home loan. This frees up money to be used for other expenses.
4. You have no tax liability
According to the IRS, money you get from a reverse mortgage is considered a loan advance rather than income. This means that unlike other retirement income such as distributions from a 401 (k) or an IRA, the funds are not taxed.
5. You are protected if the balance exceeds the value of your home
In some cases, the value of your home may be less than the total amount owed on the reverse mortgage. This can happen, for example, when house prices are falling. In this case, your heirs do not have to worry about paying the balance.
Reverse Mortgage Cons
What is the Downside of a Reverse Mortgage? While it may seem like there are many benefits, there are also some serious risks to consider.
1. You could lose your home to foreclosure
To qualify for a reverse mortgage, you must be able to afford your property taxes, homeowner insurance, HOA fees, and other expenses associated with owning your home. They must also live in the house as their primary residence for most of the year.
If at any point during the loan period you default on these expenses or spend most of the year off the property, you could default on the reverse mortgage and lose your home foreclosure.
2. Your heirs could inherit fewer
Homeownership is a key way to build generational wealth. However, with a reverse mortgage, the house usually has to be sold to repay the debt. If you die, the heirs will have to pay the full loan balance or 95% of the estimated value of the house, whichever is lower. Typically, this means selling the home or handing the property over to the lender to pay off the debt.
Not to mention that a reverse mortgage is gobbling up the equity of your home. By the time it has to be paid off, your heirs may not even have equity left.
3. It’s not free
You may not have to make payments with a reverse mortgage, but there are still many costs associated with such a mortgage. In addition to complying with your taxes, insurance, and HOA fees, you also need to pay an advance insurance premium. Usually this is 2% of the appraised value of your home. You also pay the origination fees upon completion. You have the option to include these costs in your loan balance, but that means you will get less money.
4. This could affect your other retirement benefits
A reverse mortgage may not be considered income for tax purposes, but it may affect your ability to qualify for other on-demand government programs such as Medicaid or Supplemental Security Income (SSI). It is a good idea to discuss this with a performance specialist to make sure your eligibility is not compromised.
5. Reverse mortgages are complicated
There are many rules and caveats to making a mortgage reversal. These loans come with many risks that may not be worth the extra money. You should be wary of reverse mortgage offers unless you really understand the terms.
Should You Get a Reverse Mortgage?
A reverse mortgage can be helpful, but it is not for everyone. There are a few factors that can make a reverse mortgage worthwhile:
- Your house will increase in value significantly. If you build up a lot of equity in your home, you may be able to take out a reverse mortgage and have cash left over on your property.
- You plan to stay in your house for a long time. Just like a regular mortgage, there are significant up-front costs associated with the loan. You should be sure that you plan to live in this home long enough for the cost to be worth it.
- You can cover the cost of your home. Since it is necessary to keep property taxes, insurance, maintenance, etc. updated in order to keep your reverse mortgage updated, it is important that you have adequate cash flow to cover these expenses.
Ultimately, you should weigh your decision to take out a reverse mortgage very carefully. While cash is an easy way to get hold of it, it could put your finances at higher risk in the long run. Make sure you fully understand the pros and cons of reverse mortgages before accepting one.