After years of pouring money into their homes, during their senior years borrowers can use reverse mortgages to take some cash out. The money can be a welcome supplement to Social Security payments, while allowing older people to keep living in their homes. Is a reverse mortgage right for you?
What is a reverse mortgage?
There are three types of reverse mortgages:
- Proprietary private loans backed by the financial firms that developed them
- Single-purpose reverse mortgages that some local government agencies and nonprofit organizations offer
- The Home Equity Conversion Mortgage (HECM) run by the Federal Housing Administration (FHA) which is the most popular
HECMs allow participants to borrow against some of the equity in their homes. Unlike a traditional Home Equity Line Of Credit (HELOC), there are no monthly payments. Instead, borrowers get paid. When the borrower no longer lives in the home, the cash and interest must be repaid to the lender. During the life of the loan, borrowers keep title to their homes.
To qualify for a reverse mortgage, homeowners must be at least 62 years old. They have to own their homes outright or have such a low balance on the existing mortgage that it can be paid off with the new loan. Homes that qualify must be single family or a two- to four-unit homes with one apartment occupied by the buyer. Some U.S. Department of Housing and Urban Development-approved condominiums or manufactured homes also qualify for a HECM.
The amount of money borrowers can get depends upon the current interest rate, the premium on mortgage insurance, and the age of the borrower. If there is more than one borrower, the age of the younger one is used. In general, the more equity the borrower has and the older she is the more money she can get. The FHA has capped reverse mortgage limits at $625,500 or the selling price of the home. The loans don’t have income requirements. The disbursements are not taxable.
Borrowers can get payments as a lump sum, equal monthly payments over a fixed period of months, a line of credit or a combination of these options. If the borrower receives more money than the home is worth, she will never owe more than the value of the home.
The FHA requires participants to meet with an approved HECM Counseling Agency prior to applying for a reverse mortgage. This counseling is low-cost or free.
Cons of a reverse mortgage
A reverse mortgage could have a potential impact on the borrower qualifying for means-tested government programs like Medicaid or Supplemental Security Income, especially when the disbursement is taken as a lump sum.
Lenders charge loan origination and other fees. The loans usually have variable interest rates tied to short-term indexes like the London Interbank Offered Rate (LIBOR). Interest cannot be written off until the loan is repaid. Debt increases as the equity in the home is depleted. Fewer assets are available to leave to the borrower’s heirs. Participants must still pay utilities, homeowners insurance and property taxes.
Prior to your mandated counseling session, prepare a budget and a list of questions. Don’t sign anything until you fully understand it. A reverse mortgage could potentially make a big difference in how comfortably you live during your senior years.