Jack M. Guttentag
Jack M. Guttentag, known as the Mortgage Professor. He is professor emeritus of finance at Wharton School of University of Pennsylvania, Philadelphia. MtgProfessor.com
For years, people age 62 or older who have paid off their mortgages have been able to use reverse mortgages to convert equity in their homes back into cash. But thanks to a change in the rules, there’s another way to use a reverse mortgage—to buy a home.
Benefit: You don’t have to reach as deep into savings to buy a home. And, as with a regular reverse mortgage, principal or interest payments don’t have to be made until the home is sold or you and perhaps your spouse pass away.
Before you decide to do this, consider the costs and risks to you and your heirs as well as the benefits. What to know…
• A reverse mortgage can cover some, but not all, of the home’s price. The amount available to put toward the purchase typically is one-third to a little over one-half of the home’s value, depending in part on how big a mortgage-insurance premium you are willing to pay.
Because no payments are being made, the balance due on a reverse-mortgage loan rises over time. Lenders limit the loan amount in relation to the property’s value to protect themselves. You can use the free reverse-mortgage calculator at MtgProfessor.com to get an idea of rates, fees and other costs.
Example: A 70-year-old couple wants to buy a $300,000 home that they expect to live in for the next 10 years. They can get about $100,000 from a reverse mortgage by paying the minimum mortgage-insurance premium of 0.5% of the $300,000 price, which is $1,500. If instead they pay $7,500 in mortgage insurance (a 2.5% premium), they can raise that to about $164,000.
• There are advantages to an adjustable-rate reverse mortgage. Conventional wisdom says that adjustable-rate mortgages are risky now because interest rates might rise. But an adjustable-rate reverse mortgage has an advantage over fixed—it allows a borrower to draw more money in the future by accessing an optional line of credit. In contrast, fixed-rate reverse mortgages require the borrower to draw all of the proceeds at the outset.
• Your spouse’s age matters. The US Department of Housing and Urban Development requires borrowers to be 62 years old and considers a spouse younger than 62 to be “noncontracting” to the mortgage and, under rules adopted last year, able to stay in the house after your death. However, the allowed amount of borrowing is decreased to take into account the age of the noncontracting spouse.
• You might leave nothing for your heirs. If you want to transfer your full equity in a home to your heirs, do not take out a reverse mortgage. Since there are no required payments during the life of the loan, unless you make voluntary payments, the amount owed grows every year. And if property values in your area have not increased enough, the amount that will be owed to settle the mortgage may exceed the home’s value at your death, leaving nothing for your heirs.
Typically, when the owners die, the house is sold, the balance of the reverse mortgage is repaid, and the excess is paid to the estate. If the proceeds from the sale are smaller than the debt, the loss is covered by a Federal Housing Administration reserve fund. If instead the heirs want to keep the home, the estate has up to one year to pay off the mortgage balance.
