Here at AgingOptions we’re frequently asked for our view of home equity conversion mortgages, or HECMs – more commonly known as reverse mortgages. As the pandemic has upended the plans of many older workers, forcing some to retire before they had planned to, the idea of a reverse mortgage as a way to augment retirement income seems to have regained some momentum. One trade publication, the M Report, reported on this trend in August, 2020, when they wrote that “the reverse mortgage market is stronger than ever.”
More recently, that same publication noted that home equity in the first quarter of 2021 was 20 percent higher than in 2020, adding nearly $2 trillion nationally – an average $33,400 per borrower. With that growth in borrowing power, is now the time to tap your home’s equity? Contributing reporter Rachel Hartman, writing last fall in this USNews report, says the answer isn’t that simple, because HECMs are complex, and definitely not right for everyone. We wanted to revisit the reverse mortgage question this week on the AgingOptions blog.
Reverse Mortgage Basics: a Good Way to Stay Put While Tapping Equity
Hartman begins by reviewing the basics. She writes, “For those who have paid off their home or only have a small mortgage, a reverse mortgage may be a way to help cover retirement expenses. A reverse mortgage allows you to borrow against the equity you’ve built up in your home. By doing so, you can supplement your income and remain in your current home.” This makes a reverse mortgage different from a traditional mortgage.
“With a traditional mortgage, you make payments each month to a lender,” she explains. “If you get a reverse mortgage, the lender makes payments to you. The exact amount you receive will be based on a number of factors, including your age, the current interest rate and the value of your home.” HECMs were designed to benefit senior homeowners, those 62 and older who have built up equity in a home. This type of home loan allows you to convert a portion of the equity into cash. You keep the title to your home, so it’s yours and not the bank’s. You’ll have to handle all the maintenance and upkeep and stay current on property taxes and insurance. The home also has to be your primary residence.
A Reverse Mortgage Offers Flexibility with Relatively Low Risk
One attribute of a reverse mortgage that appeals to homeowners is flexibility. “If you decide to take out a reverse mortgage, there are several ways you can receive funds from the loan,” says the USNews article. “You might opt for a lump sum, a line of credit, a monthly payment or a combination of these types of payments.” Often the line of credit is the preferred choice, allowing access to cash when needed but keeping the equity intact when the extra income isn’t required. Depending on your loan, many HECM loans include a line of credit that increases over time, whether the home appreciates or not.
“In general, reverse mortgages are known as nonrecourse loans,” Hartman writes. “This means that if you take out this type of mortgage, you won’t be responsible for paying the lending institution more than the value of the home.” Generally, the loan is paid back when the borrower leaves, either when they move or pass away. When a homeowner dies with a reverse mortgage, the family usually sells the home to pay off the loan.
Reverse Mortgage Advantages: Cash Flow with Few Restrictions
One of the biggest advantages of a reverse mortgage is cash flow to cover expenses, says USNews. This can help in times of job loss or when mutual fund investments take a dive. Some have used income from an HECM to tide them over until they reach age 70 when Social Security benefits reach their maximum.
Another advantage is that reverse mortgages don’t come with stringent credit criteria, unlike traditional loans. “There are no credit-worthiness or income requirements,” one expert told Hartman. “If you meet the age guidelines, live in the home and have enough equity, you will typically be able to secure a reverse mortgage.” On top of that, there’s no restrictions on how you spend the money, and no requirement to make payments as long as you reside in the house and take care of taxes, upkeep and insurance.
Reverse Mortgage Drawbacks: Equity is Diminished, Costs are High
But, experts warn, there are definite downsides to an HECM. “A main drawback of a reverse mortgage is that you could have fewer resources to pass on to heirs,” USNews writes. “The loan balance generally increases over time and interest can accumulate,” which means a potentially significant drop in the inheritance you’ll leave behind. Income from a reverse mortgage could potentially disqualify you from government programs, such as Medicaid or Supplemental Security Income.
One of the biggest drawbacks is the expense. In this article from the website of the Daily Oklahoman, Jim Miller, writer of the Savvy Senior blog, warned readers that “the reverse mortgages aren’t cheap. HECM loans require a 2 percent upfront mortgage insurance payment, plus an additional 0.5 percent annual charge, on top of origination costs and lenders’ fees. Any amount you borrow, including these fees and insurance, accrues interest, which means your debt grows over time.” You’ll also have to pay between $125 and $250 for special counseling approved by the U.S. Department of Housing and Urban Development to make sure you know what you’re getting into. All those fees add up.
Just last month we discovered this article in Forbes suggesting two additional reasons why an HECM could create problems. “If you plan to move within the next few years, a reverse mortgage is likely not the best option,” says the article, because a reverse mortgage complicates the selling process, and your loan costs will have been money wasted. Also, if family or friends are living with you, an HECM could leave them out in the cold. “In the event of death,” says Forbes, “your home will be sold so the reverse mortgage can be repaid by your estate. If you have friends, family or other roommates staying at your home, they’ll likely have to vacate the property.” (This doesn’t generally apply to a surviving spouse.)
Don’t Make a Decision About a Reverse Mortgage in a Vacuum
What’s the bottom line, according to USNews? “If you have been planning to leave your home to heirs, a reverse mortgage may not be the right option.” That’s because, as we mentioned above, “when the loan becomes due, family members would need to provide funds or financing to cover the loan amount at that time. If they can’t come up with the funds, they may not be able to keep the home in the family.”
On the other hand, the article concludes, “If you are short on financial resources, have no family members interested in inheriting your home and no desire to leave your home, a reverse mortgage could fit well for your situation. But a reverse mortgage is not the best choice to seek additional retirement funds for everyone.” You might consider launching a side business, refinancing your home, or selling and downsizing – all options worth a second look.
Our advice at AgingOptions is to start with the right questions. Don’t make such an important decision in a vacuum. We advise sitting down with a qualified financial planner before you make any significant financial moves. Have this expert work with you to develop a financial dashboard. Only then can you see the complete financial picture and make choices that are right for today and for tomorrow. Contact us and we’ll gladly refer you to a professional planner who can guide you.
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(originally reported at https://money.usnews.com)