What? You can borrow for retirement?!
Some people argue that parents shouldn’t save for their children’s college education. After all, they claim, you can borrow for college but you can’t borrow for retirement. Then, they suggest that you get financial advice from flight attendants, because they tell you to put your own oxygen mask on first, before helping others.
Hold on a second. You can’t borrow for retirement? Really? What about a reverse mortgage?
What is a reverse mortgage?
A reverse mortgage is like a home equity loan or home equity line of credit, but the lender pays you instead of you paying the lender. A reverse mortgage provides you with money to supplement your Social Security benefits and other retirement funds.
A Home Equity Conversion Mortgage (HECM) is the most popular type of reverse mortgage, representing about 90% of all reverse mortgages.
Most people fail to consider that their home is an asset. They often overlook it as part of their retirement planning. A reverse mortgage is one way of using home equity to cover retirement costs, without giving up your home. A reverse mortgage might be a worthwhile option for people who are house rich and cash poor.
Who is eligible to get a reverse mortgage?
To be eligible for a reverse mortgage, you must be age 62 or older. You must own your home outright. If there is an existing mortgage, the remaining balance must be small enough that it can be paid off with the proceeds from the reverse mortgage. You must live in the home. You cannot be delinquent on any federal debt, such as federal income taxes or federal student loans.
What are the financial obligations of the borrower?
The borrower of a reverse mortgage is required to maintain the home, pay property taxes, pay HOA dues, pay the utility bills and pay for homeowners insurance and flood insurance.
How much money can you get?
The amount the homeowner receives is based on the age of the younger borrower, the current interest rate and the lesser of the appraised value and the HECM FHA limit. The loan proceeds increase with the age of the borrower and decrease with higher interest rates.
If the borrower’s spouse is under age 62, the spouse does not qualify as a borrower. However, the loan proceeds will be based on the spouse’s younger age, so that the spouse can remain in the house after the borrower dies if the borrower dies first.
A reverse mortgage is usually capped at 50% of home equity. The borrower may be able to borrow more than 50%, if the loan proceeds are used to pay off an existing mortgage.
How are the loan proceeds paid to you?
If the interest rate on the reverse mortgage is a variable rate, the funds can be provided as a lump sum, as a line of credit, as level payments for a fixed term or as level payments for as long as you live in the house.
If the interest rate is a fixed rate, the funds are provided as a lump sum.
The borrower is charged interest only on the amount received, after the borrower receives it. Since the borrower does not make periodic payments like a traditional mortgage, the interest will accrue and compound, eating into the home equity.
Is a reverse mortgage taxable?
The funds from a reverse mortgage are not taxable because they are considered to be an advance on a home equity loan.
Accordingly, a reverse mortgage does not affect Social Security or Medicare benefits. However, a reverse mortgage may affect eligibility for Medicaid, SSI or other public benefits, if the loan proceeds are saved and not spent.
The interest paid on a reverse mortgage is not tax deductible until the loan is paid off.
When is a reverse mortgage repaid?
The reverse mortgage must be repaid when
- the homeowner and spouse die
- the homeowner and spouse move out of the house for 12 or more months
- the house is sold
- the homeowner and spouse fail to maintain the home or stop paying property taxes, HOA dues, utilities or homeowners insurance and flood insurance
How is a reverse mortgage repaid?
When the home is sold, the proceeds are used to pay off the reverse mortgage. A reverse mortgage is non-recourse, so you can’t owe more than the house is worth, even if the house drops in value or you outlive the loan. If the sale proceeds are insufficient to repay the reverse mortgage in full, the remaining debt is cancelled.
Any extra money after the reverse mortgage is satisfied belongs to the homeowner and spouse, or to their estate if they are deceased. No debt is passed on to the homeowner’s heirs.
Problems with reverse mortgages
Reverse mortgages are complex financial products that are difficult for many seniors to understand. Counseling is required before you can get a reverse mortgage. Even so, make sure you really understand the potential problems with a reverse mortgage before you get one. Reverse mortgages can be really confusing, even for financial experts.
Some of the key problems with reverse mortgages include:
- High up-front fees and closing costs will eat into your home equity.
- Reverse mortgages often have higher interest rates than traditional mortgages.
- The interest charges on a reverse mortgage will compound (e.g., charging of interest on interest) because the interest is not paid as it accrues. This can rapidly deplete the entire home equity.
- Mortgage insurance is required. The mortgage insurance includes an up-front fee of 0.5% of the appraised value of the home (2.5% if the borrower is taking more than 60% of home equity) and an annual fee of 1.25% of the outstanding loan balance.
- The borrower must pay an annual servicing fee in addition to mortgage insurance and interest. • The borrower must pay taxes, HOA dues and insurance and must maintain the home. If the borrower fails to pay these amounts, the borrower will be in default and the lender can force a sale of the home. Part of the reverse mortgage proceeds may be set aside to pay these expenses, if they are likely to be a problem for the homeowner. The lender can also deduct the payments from the monthly amounts paid to the borrower.
- The borrower’s family may not be able to inherit the home after the homeowner dies. To keep the home, the borrower’s heirs must pay off the reverse mortgage.
Where can you find a reverse mortgage
Be careful when considering a reverse mortgage. Shop around. Lenders can be found through HUD.gov. The FHA funds independent counselors who can provide information and advice about reverse mortgages. To find one, check the HECM Counselor Roster or call 1-800-569-4287. You can also find a counselor through the National HECM Counseling Network.
Alternatives to a reverse mortgage
There are two main alternatives to a reverse mortgage:
- The homeowner can sell the home and downsize to a smaller home or an apartment. The sale proceeds can be used to supplement Social Security benefits and other retirement benefits.
- The homeowner can obtain a home equity loan, home equity line of credit (HELOC) or cash-out refinance. This can give the homeowner money to help pay for retirement. However, the borrower will be required to make monthly payments of principal and interest in addition to insurance and taxes.
A good place to start