Advertising campaigns with aging baby boomer celebrities tout the benefits of a reverse mortgage for seniors, but they don't touch on some of the potential hazards of these loans.
On the one hand, a reverse mortgage can provide needed supplemental income for seniors in retirement. On the other hand, some seniors have run into trouble by taking out a reverse mortgage and then not being able to pay the necessary taxes and insurance on their homes. Before you decide whether a reverse mortgage meets your needs, be certain you understand this loan product and have had all of your questions answered during a session with a housing counselor with reverse mortgage expertise.
The majority of reverse mortgages are known as Home Equity Conversion Mortgage (HECM) loans insured by the Federal Housing Administration (FHA), although there are a handful of private reverse mortgages available as well. An HECM loan allows older homeowners to access the equity in their home without the need of a home equity loan and, most importantly, without requiring monthly payments on the loan.
The loan is repaid with interest when the homeowners sell the home or pass away. The owners hold title to the home during the life of the loan as long as they keep up with property taxes and homeowners insurance payments, maintain the home and pay for utilities.
Eligibility for a reverse mortgage depends on the age of the homeowners and the amount of equity they have in their home. Borrowers must be at least 62 years old and either own their home outright or have a small mortgage balance which can be paid off by the reverse mortgage proceeds. The amount you can borrow depends on a sliding scale based on your age and home equity and is capped so that you retain some home equity.
Generally, the older you are and the more home equity you have, the more you can borrow. Reverse mortgages insured by the FHA are capped at a maximum of $625,500. Your income and credit are not part of the qualification process since the loan is based solely on your age and home equity.
All HECM applicants are required to have counseling by an FHA-approved counselor to make sure they understand the loan program.
You can take the loan proceeds as a lump sum, monthly income or a combination of the two.
So far, reverse mortgages sound great: You get to stay in your home, you receive income and don't have to pay it back. However, some seniors have gotten into trouble with reverse mortgages because, in spite of tapping into their home equity, they may not have enough savings to live on in retirement and fall behind on their homeowners insurance and property tax payments. At that point, the reverse mortgage is considered in default and the homeowners can lose their property to foreclosure. In many cases, the seniors opted to take a lump sum of their home equity for living expenses and then ran out of money.
In addition to the danger of foreclosure, it's important to realize that a reverse mortgage requires significant loan origination fees, upfront mortgage insurance and closing costs that most borrowers finance into their loans. Those fees immediately lower the amount of loan proceeds you can keep.
Most HECM loans have variable interest rates. The interest payments accumulate over time so that the amount of debt owed on the loan increases. If you're concerned about leaving your home or the proceeds of your home's sale to your heirs, a reverse mortgage will reduce their inheritance.
If you completely understand your budget and the advantages and disadvantages of a reverse mortgage, this loan product could be a helpful way to increase your income during retirement and keep your home.