Reverse Mortgage Pros & Cons
In a nutshell, a reverse mortgage is a homeowner loan for people age 62 (or older) who want to turn the equity of their home into cash. It is one of the few ways that older Americans can use a significant portion of the equity they have put into their homes.
Reverse mortgages, however, come with some caveats. As a newer product it can be a little complex and expensive. To stay up-to-date on changes, you can check U.S. Dept. of Housing (or “HUD”) for the latest news on home mortgage rates.
The first thing you ought know is that reverse mortgages are only available to people who are age 62+ or older (possibly seniors 55+ depending on state laws).
You won’t qualify for a reverse mortgage if you are younger than 62, or have a bad credit score.
What Are The 3 Types Of Reverse Mortgages
There are three types of reverse mortgages for people 62+. For the most part they are the same, except for the party that issues the loan.
1. Home Equity Conversion Mortgage
By far the most popular reverse mortgage is the Home Equity Conversion Mortgage (often referred to as “HECM”). It is insured by the U.S. Federal Gov. and offered to seniors through private banks.
2. Public sector loans
A public sector loan is offered by the state and local governments. This type of mortgage loan is typically used for specific purposes, such as property tax or home repair costs. It’s mostly designed to help low or medium income homeowners.
3. Proprietary Reverse Mortgage Loans
This type of reverse mortgage is similar to the other two, but is not offered by the government. Instead, they are issued by the companies that offer them.
Is a Reverse Mortgage a Good Idea
When evaluating a reverse mortgage pros and cons it’s a good idea to lay out the types of options available. For this type of home mortgage there are 3 types which are meant to supplement a senior citizens’ income.
Below is a short list of what you should consider:
Calculate the costs first. You can expect an origination fee equal to 2% of the loan value and a 2% insurance fee, plus other home closing costs. Altogether, your costs may add up to 5% of the home’s value. Fees can be folded into the loan amount.
A good option for seniors. In 2010, the FHA introduced the FHA HECM Saver Program (or “Loan Saver”), which has much lower upfront costs. In exchange, the amount that can be borrowed is up to 18% less than with a traditional reverse mortgage and the interest rate may be a quarter to half a percentage point higher.
The payoff. How much you can borrow is a function of your age, your home’s value and current interest rates. Generally, the more valuable your home is and the older you are, the more you can borrow.
- Rate reversal. In most cases, interest rates on reverse mortgages are higher than what you normally pay for a traditional home mortgage. With a reverse mortgage, interest costs begin accruing as soon as you borrow the money.
- The type of loan. For years, adjustable rate reverse mortgages were the most popular and they allowed borrowers to take a lump sum, a monthly payment or have a line of credit, which may increase over time. But today, fixed-rate reverse loans make up about 70% of mortgages and proceeds from fixed rate loans must be taken as a lump sum.
- Best use. Generally, funds from a reverse mortgage should be used for home improvements, to supplement your income or perhaps to keep a home out of foreclosure. Lump sum payments must be managed carefully so they don’t slip away.
Figuring it out. Because of the costs and risks associated with these loans, they should be a last line of financial defense, so proceed with caution.
- Ask for help. When applying for a HECM reverse mortgage loan the borrower must first meet with housing counselors from the Dept. of Housing and Urban Development, who will walk you through the process and help you figure out how much you can borrow.
- Explore other options. Depending on your circumstances, you may also want to consider a regular home-equity loan, like a home equity line of credit, or selling your home to your children or other relative and leasing it back. If money is tight, many state governments have special programs to help seniors with assisted living home improvements or basic repairs.
Reverse Mortgage Pros and Cons
The biggest benefit for a homeowner is that a reverse mortgage allows them to access to useable cash. By borrowing against an asset, in this case a home, it’ll generate cash flow to settle other debts or help pay for medical bills.
One important note is that the amount of money a homeowner can get access will depend on age, current value of the property, interest rates offered by lenders, and fees associated with a reverse mortgage loan.
What not to do. Because this may be your last major asset, use the money carefully. Don’t waste it on a hot tub or use funds to play the stock market.
- Don’t pay fees up front. Mortgage loan fees should be included in the balance and paid when the loan is settled. Don’t let someone tell you that fees must be paid only after you have the cash in hand.
- Don’t pay off a traditional mortgage. Unless you are trying to avoid foreclosure. Look for another way to handle your current mortgage. The cost of the reverse mortgage is going to be much higher that your original mortgage loan.
- Don’t buy an annuity. Instead, pick a reverse mortgage that gives you a monthly payment. It will essentially function as an annuity for you.