Reverse mortgages, at least the government-backed variety that about 90 percent of borrowers choose, have undergone significant changes in recent months. Here's what anyone considering a Home Equity Conversion Mortgage (aka, the FHA reverse mortgage or HECM) in 2015 should know about reverse mortgage pros and cons. (This article does not cover private reverse mortgages, which are not government-backed and do not have standard guidelines and fees.)
How Reverse Mortgages Work
Reverse mortgages are a form of home equity loan -- you exchange some of your home equity for cash, and the lender records a lien against your property. What's different about reverse mortgages is that you don't have to make payments to the lender, and the loan needn't be repaid at all until you no longer occupy the residence.
Reverse Mortgage Cons
HECMs (pronounced Heck 'ems) are not the first choice of many finance experts. Home equity loans are usually cheaper, and other counselors recommend selling assets, taking in boarders and getting money from family members before resorting to reverse mortgages. Here are HECM drawbacks:
- They're expensive. Because you don't make monthly payments, reverse mortgage balances grow larger over time. That can eat up home equity more quickly than you realize. And the mortgage insurance is calculated based on the home's value, so if you just want a small loan, it can be prohibitive.
- They can promote overspending. If you see reverse mortgage proceeds as a windfall and spend without a plan, you could end up short of cash and with no home equity to fall back on. That's why the government limits how much you can cash out in your first year – it's trying to protect some home equity for future needs.
- They can render you ineligible for certain government benefits unless you structure the payout carefully. Lump sum distributions can create problems for those getting Medicaid or SSI.
- They can cause problems in your family. Some heirs don't like the idea of possibly losing "their" family home.
- There are occupancy requirements. If you have to leave your home earlier than you planned, you'll have paid all the reverse mortgage fees upfront and won't receive the benefits you expected.
Reverse Mortgage Pros
Reverse mortgages can do a lot of good when taken by the right people for the right reasons. Here are the pros:
- They're easy. Bad credit and low income don't prevent loan approval. However, the lender is required to conduct a financial assessment, and if you don't pass, it will withhold some of the reverse mortgage proceeds for home-related expenses like property taxes and insurance.
- You still own your home. When you repay the reverse mortgage, any remaining equity is returned to you or your estate. Your heirs can buy back the home for just 95 percent of its value if they choose to do so.
- You can't owe more than your home's value. If your loan balance grows larger than the property value, government mortgage insurance covers the difference -- not you and not your family.
- Counseling is required. You can't take out a HECM before completing reverse mortgage counseling with a HUD-approved counselor. This is to make sure you understand the product, know how to shop for the best one and are comfortable with your decision.
- They're safe. If you choose the "tenure" option, which provides income for as long as you live in your house, you'll keep receiving payments, even if your loan balance exceeds your home's value. You don't outlive your loan.
- They're flexible. Reverse mortgage payouts can be structured to meet a variety of needs. If you want money in reserve for emergencies, a line of credit is a relatively inexpensive option, and it will grow over time. A lump sum is good for paying off debt or financing a large purchase. Reverse mortgage proceeds can even be used to buy a home. You can also choose monthly payments to supplement your income. Or choose a combination of these methods.
- They can be less work and less expensive than selling, moving and buying a cheaper residence. Personal finance and real estate professionals estimate the cost of selling a house at ten percent of its value, while buying knocks off another two-to-four percent. So selling a $400,000 home and buying a $200,000 home could subtract $44,000 from your profits, leaving less than $160,000 in the bank. With a reverse loan, you might be able to borrow $200,000 against your house, you won't have to move and you'll stay in your $400,000 property.
Reverse Mortgages in 2015
Changes to reverse mortgage laws eliminated some of the cons that used to be associated with these loans. Non-borrowing spouses who are not on the property title (as long as they're married before taking out the reverse loan) can no longer be evicted if the borrowing spouse dies or enters a nursing facility. New financial assessments and impounding largely eliminate the risk of foreclosure. And mortgage insurance premiums for most borrowers have come down. However, one less positive change is that, in many cases, homeowners can borrow against a lower portion of their property value than they could in the past.
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