There are numerous ways to fund your retirement.
Social security benefits, retirement plans, savings, annuities, and stock investments are just a few of the common strategies which retirees use as ways to fund their retirement.
But what about reverse mortgages?
If you are looking for another option to increase the amount of funds available in your nest egg, then a reverse mortgage could be an interesting option to consider.
What is a Reverse Mortgage?
The term mortgage itself refers to a type of security interest that is attached to a property. This interest is essentially a collateral for the repayment of the monies borrowed from a bank or financial institution which were used to pay for the property.
Generally, a person who wants to buy a house will not have the full amount required to own the house outright. In these situations, a mortgage is placed on the property which guarantees the lender that the borrower will not default on the loan (or if the borrower does default on the loan, the lending bank or financial institution can repossess the property).
A reverse mortgage works in the opposite way of which a traditional mortgage works. It is a loan where the lender will pay the borrower a set sum of money which is borrowed against the value of the borrower’s primary residence. Ownership of the property stays with the borrower.
If the borrower passes away, the loan becomes due and the onus is on the borrower’s heirs to determine how they want to handle the payment, as both ownership and the loan will usually transfer to the heirs in the event of the borrower passing away.
What makes a reverse mortgage truly appealing is that the borrower will not be required to pay the funds back to the issuer unless they choose to stop living in the property or if they decide to sell the property.
Like anything else, thorough research is required to ensure a potential borrower finds the proper reverse mortgage for their specific situation. And just like purchasing car insurance or an annuity, it is wise to shop around for the best deal.
A borrower is often eligible for more money depending on what percentage of the home they actually own. In general, the older the borrower is, the less they would owe on their home if it was purchased via a traditional mortgage option. If the borrower owns the home outright, they will generally get the highest amount of money.
Reverse mortgage loans are generally tax-free and will not interfere or impact the borrower’s Social Security or Medicare benefits.
Do You Qualify for a Reverse Mortgage?
When a borrower has a regular mortgage, they pay the lender every month to purchase the home over a period of time. But with a reverse mortgage, the borrower gets a loan in which the lender pays them. It is a nice change of pace.
In order to qualify for a reverse mortgage, at a bare minimum, the borrower must own the home and be 62 years or older.
A reverse mortgage allows a borrower to take out a loan against the equity in their home. Instead of paying a monthly mortgage to the bank, the borrower can have the bank pay them a monthly mortgage payout. They also have the option of taking a line of credit or a lump sum payment. If they choose the monthly payout, the retiree can essentially receive lifetime monthly income (depending on their age, how long they will live, and the value of their home), similar to an annuity.
Reverse Mortgage Key Terms?
If you are thinking of getting a reverse mortgage, then you should become familiar with some of the lingo.
The reverse mortgage process usually starts out with an appraisal. An appraisal is a written document which gives a professional appraiser’s estimate on how much the property is worth. An appraisal usually includes the unique aspects of the property which make it valuable, in addition to a comparison of the property value versus other properties in the neighborhood.
The principal limit is your borrowing limit. Your principal limit is determined based on your age, the interest rate of your loan and the overall value of your home. If you are married and your spouse is listed as a co-borrower, the principal limit is determined based on the youngest co-borrower or the eligible non-borrowing spouse.
An eligible non-borrowing spouse is a borrower’s spouse who is not officially listed as a co-borrower but qualifies under the United States Department of Housing and Urban Development’s (HUD) rules to stay in the home in the event that the borrower passes away.
The servicer is the company which handles the day-to-day management of the loan including making the payments to the borrowers, responding to enquires from the borrower, sending and collecting occupancy certifications and monitoring the principal amount and the interest being paid.
Loss mitigation refers to a servicer’s responsibility to reduce or mitigate the loss to the investor that can come from a foreclosure. Essentially, loss mitigation are the steps the mortgage servicer will take to work with a borrower in order to avoid foreclosure.
Types of Reverse Mortgages
There are numerous types of reverse mortgages but there are three main types that you should be aware of.
- Single-Purpose Reverse Mortgages are often the least expensive option; however, they are not available everywhere. They are generally only given out for one purpose which the lender will specify clearly in the contract. An example may be a loan used to pay for repairs to the home, property upgrades, or to cover property taxes. These types of reverse mortgages are usually offered by local or state government agencies, and/or non-profit organizations.
- Proprietary Reverse Mortgages are loans offered by private companies as opposed to government agencies. Depending on the value of your home, you may get a larger loan advance with this type of reverse mortgage. There are generally no requirements to use the funds you receive on a specific purpose such as property taxes.
- Home Equity Conversion Mortgages (HECMs) are federally issued reverse mortgages which are backed by the HUD. These loans can be used for any purpose. Upfront costs with HECMs can be higher than the other options listed above.
Risks of Reverse Mortgages
Reverse mortgages are not without their risks, costs, and pitfalls.
1Not all reverse mortgages reverse mortgage lenders are created equally.
Much like annuities, there are numerous types of reverse mortgages, and it is essential that you research all of them in your state to find the perfect one optimized for your specific set of circumstances. Choosing the wrong reverse mortgage can cause you headaches down the road.
Additionally, there are numerous reverse mortgage lenders. You must choose a reputable lender and it is smart to find one that is able to provide a HECM. These types of reverse home loans are insured by the Federal Housing Administration (FHA).
2If you move out of the home you used to get a reverse mortgage, you could lose it.
The home you use for your reverse mortgage must be your principal residence. This means you must live there year-round, or at least for the majority of the year. As an example, if you move into a different home or a healthcare facility for a period of twelve consecutive months or longer, your reverse mortgage may become repayable.
The security agreement of a reverse mortgage defines the principal residence “as the dwelling where the borrower shall maintain his or her permanent place or abode, and typically spends the majority of the calendar year. A person may have only one principal residence at a time. The property shall be considered to be the principal residence of any borrower who is temporarily or permanently in a health care institution as long as the property is the principal residence of at least one other borrower who is not in a health care institution.”
3You rarely receive the full value of the loan.
The closing costs for a reverse mortgage can be downright expensive. There are origination fees, servicing fees and third-party fees.
Origination fees are monies that a lender or a bank charges a client to complete a loan transaction. Lenders usually charge the greater of $2,500 or two percent of the first $200,000 of your home’s value, plus an additional one percent for the amount over $2,500.
Servicing fees are monthly fees lenders sometimes charge to maintain and monitor your HECM for the full duration of the loan. These types of fees cannot exceed $30 per month for loans with a fixed rate or an annually adjusting rate. If the rate is variable, it can go as high as $35 per month.
Third-party fees are additional fees charged by third parties such as home inspectors, appraisers, landscapers, painters, home stagers, etc.
Interest will also accrue to the balance you owe each month. This means the amount you owe can grow substantially as your loan adds up over time. And the interest in not tax-deductible until the loan has been paid off.
4You still will have to pay your normal recurring expenses on the house.
If you get a reverse mortgage, you will still be required to pay recurring expenses such as utilities, fuel, maintenance, and property taxes. In other words, not only will interest accrue every month, but you will also need to have adequate income to cover all of the normal expenses a homeowner has.
The bottom line is a reverse mortgage offers a unique way for older homeowners to supplement their income for retirement, or to pay for unexpected expenses such as home renovations or healthcare costs.
Unfortunately, there are many scams when it comes to reverse mortgages. Lenders will often take advantage of elders in order to foreclose the property.
Private reverse mortgage issues can provide an initial bigger payday but if they are not HECM reverse mortgages, you may end up being responsible for paying the lender funds well above the actual value of the home.
Choosing a reverse mortgage is a decision which should not be rushed, and we highly advise you to seek out a HUD-approved counselor or a real estate attorney specializing in reverse mortgages prior to agreeing to a reverse mortgage.
The information in this article is just a starting point if you are thinking of getting a reverse mortgage. If you are still tempted to take the plunge after reading this, please make sure you seek out further information and understand exactly what you are signing up for.