Reverse mortgages — a special kind of home-equity loan designed specifically for older home owners to let them stay in their homes and supplement their income — have soared in popularity among financially strapped seniors. Recent changes in the law have made these mortgages even more appealing.
New law: Congress has raised the maximum loan limit that you can borrow to $625,500 in certain areas… capped the fee lenders may charge to process your loan application (origination fee) at $6,000… and allowed you to use a reverse mortgage to buy a new home.
What you must know before you jump in…
Reverse mortgages, the most common of which is known as a Home Equity Conversion Mortgage (HECM), are loans available to qualifying home owners age 62 or older. They allow home owners to borrow money from banks and mortgage lenders against the value of their homes. The home owner continues to live in the home and retains title to the property.
Unlike with a traditional loan, your income and credit score don’t matter. The lender pays you, typically in a monthly payment or lump sum or with a line of credit. The money you get is tax-free, can be used for any purpose and, if it is an HECM, is guaranteed by the federal government even if your lender is unable to pay in the future.
Interest rates that lenders charge on reverse mortgages are adjustable and based on a US Treasury rate plus a lender margin. Interest accrues over the life of the loan — but you don’t have to repay anything until you move out or die, at which point the house is sold to pay off your debt. Best of all, the amount of debt you owe, including interest, cannot exceed the market value of the home. So even if your home loses value, you or your heirs aren’t responsible for any shortfall. You are required to maintain your home while you live in it and pay your property taxes, homeowner’s insurance and utility bills (otherwise the loan comes due immediately).
Actuarial tables determine how much a borrower can withdraw from the home. Calculations are based on the value of the home, interest rate, age of the borrower and location. For an estimate of what you might receive with your home, use the free online calculator at http://rmc.ibisreverse.com.
While the payouts you receive are tax-free, reverse mortgage income can make you ineligible for certain state and federal supplemental benefits, including Medicaid, though not Medicare.
The main downside to a reverse mortgage is that it’s expensive. Even though lenders can legally charge you an origination fee of no more than $6,000, you also have to pay an up-front insurance premium that could amount to thousands of dollars. In addition, closing costs on a $400,000 reverse mortgage typically are $2,000 or more.
For these reasons, it’s often a better deal to take out a traditional home-equity loan or, if it’s available, a loan from family members.
In the following situations, a reverse mortgage can make sense…
Example: An elderly couple lived in a two-story house valued at $600,000. They sold the home and wanted to buy a one-story home closer to their children for $600,000. Getting a traditional mortgage for the new property wasn’t a good option, because they were on a fixed income and didn’t want to make mortgage payments each month. They also needed some of the profits from their old home’s sale to live on in the future.
Solution: The couple applied for, and received, a reverse mortgage of about $400,000 to buy the new house. That meant that to buy the new home, they had to put down only $200,000, which they acquired from the sale of the old house. The couple makes no monthly payments to the lender — instead, the lender will recover the loan principal plus interest when the home eventually is sold.
Reverse mortgages are complex. Careful consideration and consultation with your adviser is critical before taking the plunge. In fact, federal law mandates that you attend a session with an independent financial counselor to ensure that you understand all the implications of what you’re doing. Also be sure to…
Examples: The broker or lender tries to get you to invest your reverse mortgage loan money in costly financial products, such as deferred annuities… or the lender asks you to sign loan paperwork that’s not completely filled out.
The bottom line is that reverse mortgages are not for everyone. Spending money on the up-front fees usually makes sense only if you need the cash and you do not have another readily available source.
