I’m sure many of you have heard television pitches for Reverse Mortgages. The ads first tell you that you need to set aside at least 10 times your annual salary for retirement, or say that you should have at least $2 million to retire comfortably with rising healthcare costs, etc… and then offer a wonderful sounding solution, a magic bullet for your financial woes – a Reverse Mortgage that solves all your money problems – you get to stay in your house and you’re paid a certain monthly amount to meet various expenses.
Like everything that sounds too good to be true, there are a couple of catches… and you need to be very clear about your goals going into something like this and have reasonable expectations for what you expect to get out of it.
A Reverse Mortgage – The Basics
But first, let’s understand what a Reverse Mortgage is.
The Federal Trade Commission defines a reverse mortgage as one where you receive money from the lender and generally don’t have to pay it back for as long as you live in your home. So it’s quite different from a ‘regular’ mortgage where you make monthly payments to the lender. Most reverse mortgages are so-called home-equity conversion mortgages that are insured by the Federal Housing Administration, a federal agency that writes most of the rules for these things.
To qualify, you have to be at least 62, and use your home as your primary residence. You also have to own a significant amount of the property, although the percentage can vary. There’s also a $625,500 cap on such loans… so even if your home is worth a million dollars, you won’t receive full market value in a reverse mortgage. Wild cards include the borrower’s age, the appraised value of the property and any outstanding repairs needed to meet federal safety standards. The most attractive aspect of reverse mortgages is that no payments have to be made to the lender until the homeowner sells or vacates the property, or dies.
If the homeowner dies, heirs or the estate typically have six months to pay off the loan or walk away from the property, leaving it in the hands of the lender.
So if you want to leave your home to your heirs, don’t opt for a reverse mortgage. But if you don’t plan to leave your home to anyone, a reverse mortgage can help you turn the roof over your head into cash in your pocket, sort of as a cash-flow tool for older homeowners.
A reverse mortgage sounds pretty attractive… but know the details before you jump in.
A reverse mortgage sounds pretty attractive… but know the details before you jump in. Here’s why.
The pitfalls of a reverse mortgage
A recent article in the Los Angeles Times, “understanding the pitfalls of reverse mortgages” by David Lazarus, cites the case of a certain Mr. Lowe, a 91-year old who put up his Santa Monica house several years ago for a $180,000 loan. Mr. Lowe knew, going into the deal, that he’d still be responsible for property taxes and homeowner’s insurance. But what surprised him was the nearly $200 a month he’s now charged for mortgage insurance in addition to the $400 he pays each month in interest payments against the loan… so while Mr. Lowe got his $180,000 loan, he’s now on the hook for $7,200 a year in mortgage insurance and interest payments that he just can’t get out of.
Luckily, his Santa Monica house is worth more than $1 million and he owns it free and clear, so his $180,000 reverse mortgage won’t eat up all his equity. And he can either pay down the debt during his remaining years, or his kids could sell the property after his death and use a portion of the proceeds to cover the loan.
What to factor-in before you opt for a reverse mortgage
But there are a number of things borrowers should keep in mind before taking the reverse-
The first is the potentially high upfront cost of these loans. Closing costs typically run in the thousands of dollars, and could sometimes go as high as $15,000. That’s a big chunk of change, particularly when you consider that the closing cost of a 30-year mortgage is only around $3,000. The good news is that it is a pretty competitive market so you should shop around to get the best deal.
Many reverse mortgages come with variable interest rates, so interest payments can fluctuate over time. Also, interest is charged on your outstanding balance and accrues over time… so the size of your loan will keep rising if you don’t pay it down on a regular basis.
And then there are those insurance premiums that caught Mr. Lowe by surprise. Reverse mortgage insurance is required by federal authorities to protect both lenders and borrowers and to ensure stability in the marketplace. So expect annual insurance premiums of about 1.25% of the outstanding loan balance.
Also, because of the high upfront fees, borrowers should look into other options such as refinancing an existing mortgage, seeking a home equity line of credit or even selling their property to bolster retirement funds.
So it really depends on an individual’s situation… and if you think a reverse mortgage might be right for you, make sure you do your due diligence – read up on all the fine print and understand what you’re legally committing to.