08:32 | 08/12/2021 Print
|What Is A Reverse Mortgage?|
If you want money to pay off your mortgage, supplement your income, or pay for healthcare expenses – you may consider a reverse mortgage. It allows you to convert part of the equity in your home into cash without having to sell your home or pay additional monthly bills. But take your time: a reverse mortgage can be complicated and might not be right for you. A reverse mortgage can use up the equity in your home, which means fewer assets for you and your heirs. If you do decide to look for one, review the different types of reverse mortgages, and comparison shops before you decide on a particular company.
Read on to learn more about how reverse mortgages work, qualifying for a reverse mortgage, getting the best deal for you, and how to report any fraud you might see.
Think of a reverse mortgage like a conventional mortgage where the roles are switched. In a conventional mortgage, a person takes out a loan in order to buy a home and then repays the lender over time. In a reverse mortgage, the person already owns the home, and they borrow against it, getting a loan from a lender that they may not necessarily ever repay.
In the end, most reverse mortgage loans are not repaid by the borrower. Instead, when the borrower moves or dies, the borrower’s heirs sell the property in order to pay off the loan. The borrower (or their estate) gets any excess proceeds from the sale.
Most reverse mortgages are issued through government-insured programs that have strict rules and lending standards. There are also private, or proprietary, reverse mortgages, which are issued by private non-bank lenders, but those are less regulated and have an increased likelihood of being scams.
There are three types of reverse mortgages. The most common is the home equity conversion mortgage (HECM). The HECM represents almost all of the reverse mortgages that lenders offer on home values below $765,600 and is the type that you’re most likely to get, so that’s the type that this article will discuss. If your home is worth more, however, you can look into a jumbo reverse mortgage, also called a proprietary reverse mortgage.
When you take out a reverse mortgage, you can choose to receive the proceeds in one of six ways:
It’s also possible to use a reverse mortgage called a “HECM for purchase” to buy a different home than the one in which you currently live.4 Also called a Federal Housing Administration (FHA) reverse mortgage, this type of mortgage is only available through an FHA-approved lender.5
In any case, you will typically need at least 50% equity—based on your home’s current value, not what you paid for it—to qualify for a reverse mortgage. Standards vary by lender.
Who owns the house in a reverse mortgage?
Just like any other type of mortgage, you own the home in a reverse mortgage situation.
When the borrower dies or moves, however, the mortgage is payable in full. If you can’t, or won’t, pay off the debt, the lender can sell the home to recoup the money it’s owed, explains Michael Sullivan, a personal financial consultant with nonprofit credit counseling and debt management agency Take Charge America.
“Typically, the homeowner or beneficiaries are not responsible for any costs if the house is sold for less than the amount owed,” adds Sullivan.
Supplementing retirement income, covering the cost of needed home repairs, or paying out-of-pocket medical expenses are common and acceptable uses of reverse mortgage proceeds, according to Bruce McClary, spokesperson for the National Foundation for Credit Counseling.
“In each situation where regular income or available savings are insufficient to cover expenses, a reverse mortgage can keep seniors from turning to high-interest lines of credit or other more costly loans,” McClary says.
When you have a regular mortgage, you pay the lender every month to buy your home over time. In a reverse mortgage, you get a loan in which the lender pays you. Reverse mortgages take part of the equity in your home and convert it into payments to you – a kind of advance payment on your home equity. The money you get usually is tax-free. Generally, you don’t have to pay back the money for as long as you live in your home. When you die, sell your home, or move out, you, your spouse, or your estate would repay the loan. Sometimes that means selling the home to get money to repay the loan.
There are three kinds of reverse mortgages: single-purpose reverse mortgages – offered by some state and local government agencies, as well as non-profits; proprietary reverse mortgages – private loans; and federally-insured reverse mortgages, also known as Home Equity Conversion Mortgages (HECMs).
If you get a reverse mortgage of any kind, you get a loan in which you borrow against the equity in your home. You keep the title to your home. Instead of paying monthly mortgage payments, though, you get an advance on part of your home equity. The money you get usually is not taxable, and it generally won’t affect your Social Security or Medicare benefits. When the last surviving borrower dies, sells the home, or no longer lives in the home as a principal residence, the loan has to be repaid. In certain situations, a non-borrowing spouse may be able to remain in the home.
Here are some things to consider about reverse mortgages:
Reverse mortgages aren’t good for everyone. Only certain borrowers qualify, but their structure also only makes them appropriate for certain borrowers. A reverse mortgage may make sense for:
If you’re struggling to meet your financial obligations, a reverse mortgage may help you stay afloat. Here are a few benefits to opting for a reverse mortgage.
Reverse mortgages are ideal for retirees who don’t have a lot of cash savings or investments but do have a lot of wealth built up in their homes. A reverse mortgage allows you to turn an otherwise illiquid asset into cash that you can use to cover expenses in retirement.
Instead of having to sell your home in order to liquify your asset, you can keep the property and still get cash out of it. This means you don’t have to worry about potentially downsizing or getting priced out of your neighborhood if you had to move.
Your home doesn’t have to be paid off in order 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 put toward other expenses.
According to the IRS, the money you get from a reverse mortgage is considered to be a loan advance rather than income. That means the funds aren’t taxed, unlike other retirement income such as distributions from a 401(k) or IRA.
In some cases, the value of your home could end up being less than the total amount owed on the reverse mortgage. This can happen if home prices fall, for example. If this occurs, your heirs don’t have to worry about paying the balance.
So what is the downside of a reverse mortgage? Though it might seem like there are many benefits, there are also some serious risks to consider.
In order to qualify for a reverse mortgage, you have to be able to afford your property taxes, homeowners insurance, HOA fees and other costs associated with owning your home. You’re also required to live inside the home as your principal residence for most of the year.
If at any point during the loan period you become delinquent on these expenses or spend the majority of the year living outside the property, you could default on the reverse mortgage and lose your home to foreclosure.
Homeownership is a key path to building generational wealth. However, a reverse mortgage usually requires the home to be sold to repay the debt. When you die, heirs will be required to pay the full loan balance or 95% of the home’s appraised value, whichever is less. Usually, that means selling the home or turning the property over to the lender to satisfy the debt.
Not to mention, a reverse mortgage eats away at your home’s equity. By the time it needs to be paid off, there may not even be any equity to be left to your heirs.
You might not have to make payments with a reverse mortgage, but there are still plenty of expenses associated with one. Not only do you have to keep up on your taxes, insurance, and HOA fees, but you also have to pay an upfront insurance premium. Usually, this is 2% of your home’s appraised value. You’ll also pay origination fees at closing. You do have the option of rolling these costs into your loan balance, but that means you receive less money.
A reverse mortgage may not be considered income for tax purposes, but it could impact your ability to qualify for other need-based government programs such as Medicaid or Supplemental Security Income (SSI). It’s a good idea to discuss this with a benefits specialist to make sure your eligibility won’t be compromised.
There are a lot of rules and caveats to reverse mortgages. These loans come with many risks that may not be worth the extra cash. You should be wary of any reverse mortgage offer unless you understand the terms really well.
Who should avoid a reverse mortgage?
While there are some cases where reverse mortgages can be helpful, there are lots of reasons to avoid them. A reverse mortgage isn’t a good option if:
You can’t find a trustworthy lender or a reputable loan program
You have outside savings or life insurance that you can tap to cover expenses
You have heirs who want to inherit your property or family members who live with you and who need to stay in the property after the term of a reverse mortgage
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