The number of reverse mortgages backed by the government jumped nearly 20 percent in March and April alone from the same period in 2008. At a time when seniors have seen their retirement assets depleted by market losses, tapping home equity has been a safety net. But it can be a risky one.
If you are at least 62 years of age and have significant equity in your home, a reverse mortgage can turn that equity into tax-free cash without forcing you to move or make a monthly payment. If it’s right for you, it’s a worthwhile financial tool. If not, you could make some serious mistakes with your financial future.
A reverse mortgage gets its name because of the way it works. Instead of the borrower making payments to the lender, the lender releases equity to the borrower in a number of forms. This can include a lump sum cash payment, monthly cash payment, line of credit (which tends to be the most popular option) or some combination of the previous.
When the owner dies or moves away, the house can be sold, the loan paid off, and any leftover equity value can go to the living owner or the designated heirs. Heirs don’t have to sell the house. They can either pay off the reverse mortgage with their own funds or refinance the outstanding loan balance within six months with the option of two 90-day extensions that must be applied for.
Reverse mortgages have traditionally been chosen by older Americans who can’t cover everyday living expenses or who otherwise need cash for such things as long-term care premiums, home healthcare services, home improvements or to pay off their current mortgage or credit card greater than their income can support. More recently, though, they’ve become popular with individuals who see them as a better alternative to home equity lines. Some use the proceeds to supplement monthly income, buy a car, fund travel and purchase second homes.
Elderly borrowers are required by law to consult with a financial advisor before they’re granted this loan, because reverse mortgages can be complex and risky. Here are some issues you should discuss with your advisor:
Cost can be substantial: Generally the only out-of-pocket cost is an appraisal fee ranging from $300- $500. However, reverse mortgages are generally more expensive than traditional mortgages in terms of origination fees, closing costs and other charges. That can run between $12,000 and $18,000.
Make sure you’re not endangering Federal retirement benefits: The basic Federal Housing Administration (FHA) Home Equity Conversion Mortgage (HECM) is designed as tax-free income to the senior receiving Social Security income. However, if the total liquid assets exceed allowable limits under federal guidelines, you might endanger your benefits.
Rates can be higher: Reverse mortgages have rates that are typically higher than those charged on conventional mortgages. Interest is charged on the outstanding balance and added to the amount they owe each month.
The mortgage can be called: The homeowner or estate always retains title to the home, but if you change your primary residence or fail to pay property taxes, adequately maintain the home or pay insurance premiums, the lender can declare the mortgage due or reduce the amount of monthly cash advances to pay those overdue amounts.
Mike McCann is a Certified Financial Planner and Accredited Investment Fiduciary. Email him at Mike@MoneyAZ.com or call 602-281-4357 with any questions about reverse mortgages.
A portion of this article was produced by the Financial Planning Association, the membership organization for the financial planning community, and provided by Mike McCann, a local member of FPA.