You may have seen ads for a reverse mortgage on TV and thought, “Hey, this seems like free money!” The reality is that reverse mortgages are a lot more complicated than that. While they can be a great way for seniors to receive a loan using their home’s equity as collateral, they do come with many strings attached that you have to be wary of. Here’s what you need to know before you take out a reverse mortgage:
What Is A Reverse Mortgage?
A reverse mortgage is a specific type of loan for homeowners 62 or older who either own their homes or are close to paying off their primary mortgage. It uses the equity you’ve built in your house to provide you with tax-free cash that doesn’t need to be repaid as long as you’re still living in the home. Once you move out, sell, or die, the loan must be repaid by either you, your spouse, your heirs, or your estate.
There are three different kinds of reverse mortgages:
Home equity conversion mortgage (HECM): This is the most popular reverse mortgage, allowing you to use the money you receive for whatever you want. The money comes through private lenders but is insured by the Federal Housing Administration (FHA). You’re also required to receive borrower counseling before you can get an HECM.
Single-purpose reverse mortgage: With this type of reverse mortgage, you’re restricted in what exactly the money you receive can be spent on. This type of mortgage is typically available through some nonprofits and state or local government agencies.
Proprietary reverse mortgage: If you go through a private lender, this is the mortgage you’ll most likely get. It isn’t subject to the same rules and regulations as federally backed reverse mortgages, and is typically a better option if you have a higher-value home and want to receive more of your equity.
How Do You Receive The Money?
You can choose however you’d like to receive the money for your reverse mortgage, whether it’s fixed monthly payments over the course of a fixed period, a lump-sum payment, or a line of credit you can draw from. You can even split it up between different options; the choice is up to you.
As for how much you can get, that amount depends on factors like your age, your spouse’s age, current interest rates, and the value of your home. HECM’s are capped at $625,500, and you can only access up to 60% of that money in the first year; after that year, you can receive the rest. With other reverse mortgages, there is no limit, and you can be eligible for a larger loan depending on how old you are and the value of your house.
What’s The Cost?
There are substantial costs for taking out a reverse mortgage. Interest rates are usually higher than traditional mortgages, although HECM’s typically offer lower rates than proprietary reverse mortgages. Your interest rate is most likely going to be variable, determined by a rate index that fluctuates with the market. Interest compounds until repayment, so you could end up owing quite a bit in the long run.
There are also many fees associated with a reverse mortgage, many of which are also associated with a conventional mortgage. Origination fees, home appraisal fees, closing costs, service fees, and mortgage insurance all add up to quite a hefty sum which will usually be rolled into your loan. This will increase the amount of interest you owe in the long run, so carefully consider whether or not you can afford to pay back these fees.
Pros Of A Reverse Mortgage
Needed income: If you’re over the age of 62 and struggling financially, a reverse mortgage may be the best way to provide you with the funds you need to get by. This is the primary market for reverse mortgages.
Easy eligibility: Many people who don’t have the steady income or credit to qualify for a conventional loan are eligibly for a reverse mortgage if they own their own home. Your home’s equity can be leveraged to help you receive money when you may not otherwise qualify.
Flexibility of payment: The choice you have in how you’d like to receive the payments for your reverse mortgage make it an attractive choice, especially since the funds can be used for whatever you’d like.
No taxes: You don’t get taxed on the money you receive from a reverse mortgage, although your interest is not tax-deductible until you repay the loan.
Cons Of A Reverse Mortgage
High costs: The high interest rates and fees associated with a reverse mortgage make it a more expensive loan choice than many others. If you’re considering moving in the short term, a reverse mortgage is not the best deal for you.
Loss of freedom:Reverse mortgage payments will give you freedom in the short-term to pay your bills and spend money however you like, but in the long-term it takes away your options to move or enter an assisted living facility without having to repay your loan.
Loss of benefit eligibility: If you’re eligible for Medicaid or Supplemental Security Income (SSI), you may find that eligibility affected by the addition of the money you receive from reverse mortgage payments.
Home maintenance: You’ll be required to maintain the upkeep of your home to keep the value of your home high. You’ll also be required to maintain timely monthly payments of homeowners insurance and property taxes; missing or falling behind on any of these could require you to repay your loan.
Transfer of debt: One of the biggest downsides to a reverse mortgage is the burden it places on your heirs after you die. If you haven’t already repaid the loan, whoever inherits your home will have to pay back the reverse mortgage or sign over the deed to the lender. If they want to keep your home, they’ll have to pay it off with other resources.