Very few people who sign up for reverse mortgages are dummies. They're mature homeowners, generally with a lifetime of experience and achievements behind them.
However, reverse mortgages are a fairly strange and recent innovation. So even very smart people can benefit from a guide for dummies.
Why Have a Reverse Mortgage?
In some ways a reverse mortgage (also known as a home equity conversion mortgage or HECM) is a home loan like any other. But it differs in one key respect: You don't have to make payments every month – or, indeed, at all. Instead, the payments that would normally pay down your loan and cover the accumulating interest are continually rolled up, and only fall due when you move home. Ideally, you don't move, and your estate pays everything out of the proceeds of the sale of the home after your death.
How does that work? Well, you're accessing the "equity" you've built up in your property over decades of mortgage payments and home price inflation. Your equity is just the amount by which the current market value of your home exceeds the current balance(s) on any mortgage(s) you have on that home.
How You Receive Your Money
Time was when most people took the proceeds of their reverse mortgage as a lump sum, and you can still do that, but only if you opt for a fixed-rate reverse mortgage. But, unfortunately, those tend to release less money. Recent regulations have tried to protect borrowers by encouraging them to take at least some of the proceeds in other ways. You can choose from:
- Tenure – You receive a fixed sum every month for the rest of your life. If there are two of you, the payments end only when the second person dies.
- Term – You get a fixed sum every month for a set period. You agree with your lender in advance how much and for how long.
- Line of credit – You can draw down on your line of credit whenever you need to until you reach your limit. Again, you agree with your lender in advance what that limit will be.
- Modified tenure – You get a smaller fixed sum every month for the rest of your life, but also have a line of credit to cover unexpected expenses and emergencies.
- Modified term – You get a smaller fixed sum every month for a set period and additionally have a line of credit.
What Are Your Obligations?
You may not have to make payments on your loan every month, but you still have certain financial obligations. You MUST:
- Stay current on your property taxes
- Pay to insure the home, as you would be obliged to do with any mortgage
- Maintain the home in decent condition
If you fail to do any of those, you could be in breach of your mortgage agreement, and face foreclosure. Many of the horror stories you occasionally hear about reverse mortgages arose from people falling foul of these obligations. And they're the reason borrowers are now encouraged to take some of the proceeds of the loan in the form of continuing income. Some lenders may insist on holding back some of the proceeds of your reverse mortgage to help cover these if things go wrong.
Who Can Get a Reverse Mortgage?
The rules are pretty straightforward. You MUST:
- Be a homeowner
- Live in the home you're reverse mortgaging
- Be 62 years of age or older
- Have paid off your old mortgage or be left with only a small balance, which must be paid off as part of the reverse mortgage process
- Be able to afford to keep up with the three obligations listed in the previous section
What About Your Heirs?
Every month, the interest on the loan (and the cumulative interest on the interest) piles up. So a reverse mortgage can quickly whittle away the home equity your heirs stand to inherit from your estate.
But neither you nor they are obliged to take responsibility if you end up with a debt that's bigger than the value of your home. Suppose you live to be 110 years, and the amount you borrowed plus interest far exceeds the home's sale price. That's the lender's problem. Neither your estate nor the beneficiaries of your will have to make up the difference, and your heirs can still inherit your savings and other assets.
If your heirs are your kids or other close relations, it's often a good idea to discuss your reverse mortgage plans with them before you sign the agreement. But you're not obliged to do so.
If you share the mortgaged home with a spouse or partner, it's a good idea to name that person on the mortgage agreement regardless of whether he or she is your principal heir. It's possible he or she will be able to continue to live in the home after your death even if you don't, but it may not be certain
How Much Can You Get?
There's no easy formula for this, and you really need to get reverse mortgage quotes to be sure. As a rule, you'll be able to borrow more if:
- You're older – The older you are, the fewer the number of years interest is likely to pile up, and the greater the amount you can borrow – see How Your Age Can Affect Your Reverse Mortgage
- You own a more valuable home – The higher the value, the greater the dollar value of your equity
- Current mortgage rates are low – Although many reverse mortgages have adjustable or variable rates, low mortgage rates on the start date on your loan help you borrow more
- You choose a type of reverse mortgage that frees up more equity
A couple of other points:
- If there's more than one borrower named on the loan agreement, the age of the younger or youngest will be used to calculate the amount you can borrow.
- With HECMs, the FHA mortgage limit of $636,150 applies as a cap on the amount you can borrow, even if your home's worth millions. Try non-FHA lenders if that's an issue.
Do You Now Know Enough?
Are you now sufficiently well-informed to go ahead and sign up for a reverse mortgage? No. You may know now whether the idea's worth exploring further, but you're at a point in your life when second chances are rare if you make a bad decision. And it's also a time when you need to view your finances strategically and as a whole, including the tax implications of changing your current arrangements.
If you opt for an HECM from the FHA, you'll have to undergo mandatory, free or low-cost counseling from an approved source before you can commit yourself. But whichever sort of reverse mortgage you choose, it's a good idea to take advice first from a trusted and independent professional, such as an accountant, lawyer or financial advisor.