The Five W’s on Reverse Mortgages
For many American families, one of their largest assets is their home. A reverse mortgage can be used to unlock a home’s equity without selling the home. The cash can be used to pay-off an existing mortgage and/or other debts, provide an additional stream of retirement “income,” or for home repairs and improvements.
Who: Homeowners age 62 and older qualify if they have equity in their home (home value, minus debt, equals equity), the property is single family, and serves as the primary residence. If a home is owned jointly by husband and wife, both will need to meet the age requirement. Once approved, the reverse mortgage will replace the first mortgage on the home.
What: A reverse mortgage is similar to getting a home equity line, but without having to make payments. Depending on the particulars, roughly 50% to 70% of a home’s value can be obtained. Unlike conventional home mortgages, where the homeowner pays monthly interest and principal back to the lender, the money lent via reverse mortgages does not have to be paid back (as long as certain basic conditions are met, such as maintaining the property, paying property taxes and insurances, and residing in the home). At the homeowner’s death, the beneficiaries have up to one year to 1. Pay-off/re-finance the mortgage and keep the house; 2. Sell the house, pay-off the mortgage, and keep the difference (if any); or 3. Surrender the home to the lending institution.
Three general types are available:
1. Single-purpose reverse mortgages: offered by some nonprofit organizations as well as state and local government agencies and can be used for only one purpose. For example, the lender will specify that the money is to be used to pay for home repairs/improvements or for property taxes. Area Agencies on Aging can offer information on these types of programs. Visit www.eldercare.gov or call 800-677-1116.
2. Federally-insured reverse mortgages (aka HECMs - Home Equity Conversion Mortgages): backed by HUD (the U.S. Department of Housing and Urban Development), are widely available and can be used for any purpose. When calculating how much the borrower can take, the lesser of the appraised value or a $625,500 cap is used. The HECM has three primary payment options: a “tenure” option that provides a fixed monthly lifetime payment while residing in the home, a “term” option that provides a fixed monthly payment for a pre-determined period, or a line of credit that lets the borrower control when the monies are borrowed and received. Before applying for a HECM, borrowers must meet with a counselor from an independent government-approved housing agency. The counselor will explain and compare different types of loans as well as the different payment options, costs, and financial implications. Alternatives to the loan are also discussed, based on the borrower’s individual situation. For a list of local counselors, visit www.hud.gov or call 800-569-4287.
3. Proprietary reverse mortgages are private loans backed by the companies that develop them. Borrowers with more expensive homes may choose this option for greater flexibility of terms and a larger potential advance; the $625,500 federal cap may be exceeded.
When: There are advantages to waiting until a later date to get a reverse mortgage. First, from a general financial planning perspective, it is usually best to not get a loan until the money is needed. In the case of reverse mortgages, interest still accrues even though no payments are due. Second, because age is a factor in determining how much can be borrowed, older homeowners can typically pull out more of their homes’ equity than their younger cohorts. On the other hand, by drawing on the equity in their homes in this manner, many people have been able to delay taking Social Security payments and put off drawing on taxable sources of income (e.g., 401(k)s and IRAs). It is also important to note that the proceeds from a reverse mortgage should not be taxable (no matter how a reverse mortgage might be described, it is still a loan, and, therefore, not income).
Why: I have seen, firsthand, how reverse mortgages can be used effectively as part of an overall financial plan. But it is important to keep in mind if these financial products are not used correctly, the outcome can be unfavorable for those involved. My research on this topic revealed some very strong opinions about reverse mortgages; the key is to understand how they work, and if they make sense for your situation.
Where: Many mortgage brokers and major lending institutions offer reverse mortgage products. The National Reverse Mortgage Lenders Association publishes a list (by state) of approved lenders who originate reverse mortgages. The www.hud.gov website site also has a list of lenders.
The decision to get a reverse mortgage is very individualized. It is not for everyone. While I have advised my own clients to use other assets first, these products can be a real “financial lifesaver” when they are used properly. Free information on reverse mortgages is available from the National Council on Aging at 800-510-0301.
David D. Holland, a CERTIFIED FINANCIAL PLANNER™ practitioner, hosts a weekday radio show. He has also authored two books in his Confessions of a Financial Planner series. Holland offers investment advice through Holland Advisory Services, Inc., a registered investment adviser in Ormond Beach. He can be contacted at (386) 671-7526. Email your financial questions to info@DavidHolland.com.