Eric is a 75-year-old male. He is the sole owner and resident of a house that was recently appraised for $300,000 in Vienna, Virginia. He owns the home outright, which means he does not currently have a mortgage or line of credit of any kind. Based on these facts, Eric can get a lump sum payment of $172,674 according to a reverse mortgage calculator.
Is a reverse mortgage a good financial tool? The answer to that depends not on the general design of reverse mortgages, but on their specific terms and how well they apply to your situation. Since this is a decision you may be making about your most valuable asset, before signing up for a reverse mortgage it is important that you understand them well enough to weigh the benefits against the costs and potential pitfalls.
Who Is Eligible for a Reverse Mortgage?Eligibility for a reverse mortgage depends on the following factors:
- Age. You must be aged 62 or older to qualify for a reverse mortgage.
- Equity in home. You must either own your home outright or have paid down the bulk of the existing debt on the property.
- Residency. The home you plan to borrow against must be your primary residence.
- Financial resources. Keep in mind that even after you take out a reverse mortgage, you will still own the property. Therefore, you will continue to be responsible for meeting the ongoing expenses associated with home ownership, such as property taxes and insurance premiums. In order to protect the property that is being used to secure the loan, the lender will want to establish your ability to meet those obligations.
- No federal debt issues. If you are delinquent on any form of federal government debt, including taxes, you will not be eligible for a reverse mortgage.
- Type of property. To be eligible for a reverse mortgage, the property you intend to borrow against must be a single-family home, a 2 to 4-unit home with one unit serving as your primary residence, a HUD-approved condominium, or a manufactured home that meets FHA lending requirements.
How Does a Reverse Mortgage Work in Terms of Cost?There are two major categories of expense associated with a reverse mortgage: interest rates and fees. It is important to note that even reverse mortgages sponsored by government agencies like the FHA are offered by private lenders. Those lenders offer different terms, so it is vital that you identify all sources of reverse mortgage costs in order to make a thorough comparison of the terms being offered.
Here are some of the costs to look for:
- Interest rate. The accumulated amount you have borrowed through the reverse mortgage is charged an interest rate, so this is a key point of comparison when shopping for one of these loans. Note that the interest rate may be fixed or adjustable. You may get a lower upfront rate by opting for an adjustable rate mortgage, but this does pose the risk that the rate might rise later in the loan. In fact, the nature of a reverse mortgage heightens the risk posed by an adjustable rate mortgage, because the amount you borrow increases over time, and the more time goes by the more uncertain future interest rates become.
- Mortgage insurance premiums. This is different from – and in addition to – your home owner's insurance. Mortgage insurance protects lenders against non-payment by borrowers. Depending on how the proceeds of your reverse mortgage are paid out, there will be a mortgage insurance premium of between 0.5 percent and 2.5 percent at the start of the loan, followed by annual payments of 1.25 percent of the outstanding loan balance.
- Origination fee. These can total up to $6,000. Lenders can charge the greater of $2,500 or 2 percent of the first $200,000 of your home's value, and then 1 percent of the value over $200,000.
- Other closing costs. Miscellaneous closing costs can come from a variety of sources, such as appraisal fees, title search and insurance, inspection, taxes, and administrative fees.
- Servicing fees. These are ongoing monthly fees the lender charges for processing payments, sending statements, and generally keeping up with your loan account. Servicing fees can be up to $30 a month if the interest rate is fixed or adjusts annually, and up to $35 a month if the interest rate adjusts monthly.
Is a Reverse Mortgage Right for Me?If the first question people typically have about this financial tool is "how does a reverse mortgage work", the ultimate question is whether it is right for you. The facts and circumstances vary in each case, which it is why it is important to participate in a session with a reverse mortgage counselor first. However, here are some general characteristics that make reverse mortgages a good fit:
- You plan to stay in your home for a long time. Because of the significant upfront costs involved in a reverse mortgage, the economics make the most sense if you plan to stay in your home for a long time. If you've been considering relocating for retirement or otherwise giving up the house, a reverse mortgage may not be for you.
- You have confidence in your health. One aspect of being able to plan on a long-term commitment to staying in your home is whether your personal and family medical histories suggest you will be able to continue to handle living there. It helps if the property can be made reasonably senior-friendly.
- Your financial resources are limited. A reverse mortgage makes the most sense if you do not have more accessible resources to draw upon for retirement.
- You were not counting on leaving the property to heirs. The reverse mortgage may wipe out all or some of the equity in your home, and unless your estate can pay off what you have borrowed when you pass, the property will go to the lender.
Alternatives to Reverse MortgagesReverse mortgages are useful in providing a steady income stream to older homeowners, but they are a fairly expensive way to access the equity in your home. If you haven’t paid off your mortgage in full, and still have a significant balance left, you may want to consider other options before going down this path. Here are some alternatives to consider:
- Other retirement assets. If you are old enough to qualify for a reverse mortgage, you should be old enough to tap into your retirement savings without penalty except possibly for ordinary income tax. If this is sufficient for meeting your ongoing needs, it is a much more cost-effective way of accessing your assets than a reverse mortgage.
- Refinance. Refinancing your current mortgage may help as an alternative to a reverse mortgage in a couple ways. If you can lower the interest rate or lengthen the remaining mortgage term, you should be able to reduce your monthly payment and ease some pressure on your budget. If you do a cash-out refinancing, you can get some access to the equity in your home to meet short-term or temporary needs.
- Downsize your home. If your kids are out of the house and you are starting to struggle to keep up with a larger property, moving to a smaller home might be the right move anyway. If you sell your home and downsize to a less expensive property, you can both lower your monthly expenses and redeem some of the equity you've built up for cash.
- Move to an apartment. Many older people decide to give up the responsibilities of home ownership for the relative simplicity of living in an apartment. In particular, this might be the right move if you could benefit from some of the services offered by a facility that caters to older residents.
- Ask your children to buy your home. If your home is filled with memories of your children’s childhoods and they can’t bear to see it sold to another family, ask them to take over the mortgage. This will allow you to stay in your home and the house is able to stay within the family along with all the cherished memories.
- A home equity loan. If you’re not looking for a solution to supplement your income and your financial need is short-term or temporary in nature, a home equity loan or home equity line of credit might be a more cost-effective way of tapping into the equity in your property.