Reverse Mortgages: Make Sure You Don’t Become A Prisoner In Your Own Home
Eric Stewart ● November 17, 2015
Over the past decade, reverse mortgages have been aggressively pitched in TV ads as an easy way for seniors to cash in their home equity to pay for living expenses. In reality, reverse mortgages can be a good option for seniors in certain economic situations, providing greater financial security and allowing them to age in place. In other circumstances, it could potentially create financial distress and keep seniors trapped in a home that no longer suits their physical needs.
Let’s first discuss what a reverse mortgage is and then I will highlight a couple examples from my years in real estate to show how reverse mortgages can be both beneficial and detrimental to one’s financial, physical, and emotional well-being.
What Is a Home Equity Conversion Mortgage (HECM) or Reverse Mortgage?
A Home Equity Conversion Mortgage (HECM) is a special type of FHA loan eligible to homeowners 62 years of age or older that lets borrowers convert a portion of the equity in their home into cash. The loan is called a reverse mortgage because the traditional payback stream is reversed. Instead of making monthly payments to a lender (as with a traditional mortgage), the lender makes payments to the borrower. In order to be approved for this type of loan, borrowers must still have the financial resources to pay ongoing property charges including taxes and insurance, and the home must be their principal residence.
How Much Money Can Be Borrowed and How Much Does the Loan Cost?
The amount of funds that can be received depends on the age of the youngest borrower, the value of the home, the interest rate, and upfront costs. The older a person is, the more proceeds he or she can receive. To get an idea of how much you may be able to borrow, view this Reverse Mortgage Calculator.
In most situations, loan disbursements are tax-free. Funds can be delivered as a lump sum, as a line of credit or as fixed monthly payments. Borrowers can also use more than one of these options, for example, take part of the proceeds as a lump sum and leave the balance in a line of credit. As payments are received, the owner’s equity in the home decreases.
Loan fees, which include an origination fee and closing costs, can be paid out of the loan proceeds. This means a borrower incurs very little out-of-pocket expenses to get a reverse mortgage. When the loan is fully paid out, the balance equals the amount borrowed plus interest (many reverse mortgage loans use adjustable interest rates) and mortgage insurance. Thus, the loan balance grows as the borrower continues to live in the home. In other words, when the borrower sells the house, he or she will owe more than originally borrowed.
What Happens if the Balance of the Loan is More than the Value of the Home?
A reverse mortgage loan is “non-recourse,” meaning that if the borrower sells the home to repay the loan, the borrower or their heirs will never owe more than the loan balance or the value of the property, whichever is less; and no assets other than the home must be used to repay the debt.
All proceeds from a home sale beyond the amount owed belong to the borrower or his or her estate. This means that any remaining equity can be transferred to your children or other beneficiary.
In a Reverse Mortgage, Does the Bank Then Own The Home?
With a reverse mortgage, the borrower always retains title to or ownership of the home. The lender never owns the home even after the last surviving spouse permanently vacates the property.
How a Reverse Mortgage Could Help Or Hurt You
A former client of mine lives in a quaint home in Wheaton, MD. The house has an approximate market value of $250k. He thought about moving to Frederick, MD, but when he looked at residential options there, they cost more, were much smaller in size, and he would be farther away from his family. By obtaining a reverse mortgage, he can age in place by staying in his current home, where he is already comfortable and has more space. Through the loan payments he receives, he can cover his living expenses and also have the funds for other costs, such as unexpected medical bills. Additionally, he never has to worry about paying a mortgage back and never has to move! In this situation, the reverse mortgage was an ideal option.
I have another past client who some years ago decided to age in place and borrowed against her property using a reverse mortgage. She received monthly disbursements for years. Now, she needs to move because the stairs are unmanageable, but unfortunately she can’t afford it since most of the equity in her house has been drained due to the reverse mortgage. She has the security that she never has to move out of her home, but she is not living where it is best for her in light of her physical challenges. She has essentially become trapped in her own home. So, think about how long you want, or can stay, in your house before you get a reverse mortgage.
All borrowers of reverse mortgages are required to undergo a mandated counseling session. If your pursue this type of loan, make sure you fully understand the terms and conditions as a reverse mortgage could potentially make a big difference in how comfortably you live during your golden years.
To learn more about reverse mortgages, visit the National Reverse Mortgage Lenders Association website. There you can get more information on how reverse mortgages work and find a lender in your area. For additional information, you can visit HUD’s website for Home Equity Conversion Mortgages for Seniors.
Should You Stay or Should You Go?
Are you not sure whether you want to age in place or downsize to a smaller residence? Download our FREE Rightsizing Guide, which provide tools to help you determine whether you should move or stay put. By thinking through the rightsizing process, you can determine what living arrangement will fit both your current, and future, needs.
Sources of HECM Information: National Reverse Mortgage Lender Association and HUD.