Is a reverse mortgage a good idea? The answer is maybe.
Backed by the federal government, celebrity sales pitches for a “home equity conversion mortgage” (HECM) – the reverse mortgage program’s official title — have saturated our airways. Who doesn’t want to believe “The Fonz,” grown old along with the rest of us, when he looks intently at the camera to say go ahead, it’s a great decision. He’ll throw in a free magnifying glass (no obligations) in the bargain. Law & Order actor Fred Thompson, too, is eager to convince us and we want to believe his sincerity. His days as a U.S. Senator and as a candidate for office of president of the United States lend further credibility to his message.
What is a reverse mortgage?
A reverse mortgage is a type of loan that allows an owner to convert some of the equity in a principal residence into cash. Repayment is not required until the owner dies or the home is sold. The owner (as well as the spouse) must be at least 62 years old and own the home outright or have a mortgage balance low enough to be paid off at closing with proceeds from the reverse loan. And the owner must live in the home.
After taking into account the initial mortgage amount, the rate at which interest accrues, the length of the loan and the rate of home value appreciation the reverse mortgage is structured so that the amount will not exceed the value of the home over the life of the loan. The Department of Housing and Urban Development (HUD) assumes residential property appreciates at an annual rate of 4 percent.
By HUD rules, HECM money is distributed in one of five payment plans:
1. Tenure. Equal monthly payments continue as long as at least one borrower lives and occupies the property as a principal residence.
2. Term. Equal monthly payments continue for a fixed period of time.
3. Line of Credit. Unscheduled payments or installments are paid when the borrower chooses until the line of credit is exhausted.
4. Modified Tenure. This is a combination of line of credit and tenure payments for as long as the borrower remains in the home.
5. Modified Term. This is a combination of line of credit and term payments for a fixed period of time determined by the borrower.
Who can get a reverse mortgage?
The owner must have a substantial equity – at least 50 percent – built up in the home. Simply put, you must own more of your home than the bank does. There are no spending restrictions. However, the owner must continue to maintain the home, pay real estate property taxes and carry homeowners insurance, including flood insurance in some cases.
A reverse mortgage provides steady, predictable income and it is relatively easy to qualify. An owner’s credit is not taken into account because there is no need to make payments. The home is the collateral. If the borrower dies and the home is sold for less than what is owed, HUD takes the loss, not the borrower’s heirs.
HECMs are especially appealing to a large percentage of the population that counts on a portfolio of securities like a 401(k) and IRA to make ends meet. When the market plummets, as it has done in recent years, portfolio income also declines. To maintain something approaching a predictable monthly income, home-owners have increasingly turned to the reverse mortgage as the solution to their cash flow problems. The chief concern for retirees in this situation is to not outlive their money.
For other retirees, the priority may be to have more money to spend. A childless couple or those who are not much interested in leaving a legacy of wealth to others can spend a chunk of the inheritance on themselves, in their own lifetime. Grandparents on a fixed income may wish to help a young family member earn a degree without taking on a mountain of debt.
How much does a reverse mortgage cost the borrower?
Reverse mortgages are flexible and the money can be used for any purpose. However, CBS MoneyWatch reported last year that the costs are significant. Borrowers will pay a loan premium, an annual premium and a monthly service charge. HECMs have hefty origination costs relative to other types of mortgages and these costs become part of the initial loan balance and accrue interest.
Should I get a reverse mortgage?
Reverse mortgages are expensive and they come in different packages. One size does not suit all. That magnifier Henry Winkler wants to give us may be necessary to weed through the fine print.
Use this calculator to estimate the amount of cash that might be available to you, comparing the mortgage amount, the property value and age of owner. The older you are and the more equity you have in your home, the more the bank will pay out. Talk to a licensed financial advisor or retirement planner to determine whether a reverse mortgage is your best option.
Kimberly Rotter is a writer and small business owner. She is a featured contributor on Credit Sesame, and writes professionally in several industries, including finance, education, the environment, and health and wellness. Connect with Kimberly on LinkedIn, Google+ and Facebook.