Reverse mortgages are a relatively new product to the financial industry. Even though the first reverse mortgage was written in Maine in the early 1960s, they have not become popular until more recently.
Benefits of a Reverse Mortgage
The main benefit of a reverse mortgage is that seniors who have run out of assets to draw from can use the equity in their home to maintain their standard of living. In simple terms, a reverse mortgage allows a borrower to cash out a certain amount of money from the equity in their home to use as they wish. They can receive the money as a lump sum, fixed monthly payment or a line of credit.
Some of the non-conventional ways people are using these mortgages:
- To pay off unexpected medical bills
- To renovate their home so they can age comfortably in place.
Unlike a traditional mortgage or home equity loan:
- The homeowner does not have pay the loan back until they either move or die.
- The interest due accrues instead of declines over time. This is because the borrower is not making payments to pay back the loan.
The older you are and the value of your home dictates the amount of money you can get. Exactly how much can be borrowed is based on a number of formulas. But that is beyond the scope of what I want to talk about here. Suffice it to say, the amount that can be borrowed is a function of your age (minimum age 62) and the amount of equity in your home.
Another benefit is that the credit worthiness of the borrower is a moot point. The mortgage is backed by the equity in the home and an insurance policy tied to the reverse mortgage. So the borrower could have disastrous credit and still obtain the reverse mortgage.
Risks of Reverse Mortgages
Although reverse mortgages can be a great program, they have a number of drawbacks and have received a great deal of negative publicity in recent years for a number of reasons.
- The origination costs are a bit higher than traditional mortgages. The up-front fee is 2.0% for every $100,000 in appraised value up to $6,000.
- The borrower finances an annual insurance policy with a mortgage insurance premium (MIP) of 0.5% of the amount borrowed.
- Interest accrues and is added to the principle. Therefore, the amount of equity left over for the borrower’s children may be minimal. It will depend upon the growth of real estate values (or lack thereof) and possible longevity.
- Commission-based mortgage brokers normally sell reverse mortgages. Brokers don’t always have the borrower’s best interest in mind.
- Having a reverse mortgage may effect needs-based government programs such as Medicaid. (Social Security benefits are generally not effected by reverse mortgages).
- There are a multitude of scams targeting seniors using reverse mortgages.
When to consider a reverse mortgage
Throughout my career and despite the drawbacks, I have recommended a reverse mortgage on numerous occasions. But, likewise, I have also discouraged people from entering into a reverse mortgage.
The truth is everything in life has pros and cons. The question of whether or not a reverse mortgage is right for you depends solely on your personal situation.
There are a number of circumstances where a reverse mortgage is suitable:
- Those with no other sources of income to draw from including family members. (Family member funded reverse mortgages can be a very good option).
- People who do not have dependent children relying on them for ongoing support. Those who do, such special needs situations, should not enter into a reverse mortgage.
- Those who are not receiving benefits from a government program such as Medicaid.
- People who are in the home they plan on never leaving.
Although reverse mortgages are beneficial in some cases, you should consider all your options and choose wisely. The FHA requires that you receive counseling before being approved for a loan to explain the loan’s costs and financial implications which minimizes the risks listed above. However, I strongly suggest hiring a Certified Financial Planner (CFP) to help you determine if a reverse mortgage is right for you. They will delve into your personal situation well beyond the level that a reverse mortgage councilor will.