Getting income for life and staying in your home as long as you want sounds like the perfect combination. If you're cash-strapped and having trouble making ends meet, a product that promised a deal like that would look like a life-saver.
For homeowners over 62, reverse mortgages offer exactly that promise. To seniors who struggle with ever-increasing costs of living and falling CD income, it sounds like the perfect solution -- they can supplement their cash flow without having to sell their home and move.
But before you or your loved ones decide on a reverse mortgage, make sure you understand its limitations and shortfalls as well as its promises.
What a reverse mortgage does
Reverse mortgages allow you to tap into your home's equity without having to sell it. Unlike regular mortgages, you don't have to make any monthly payments to your lender, and the lender can't collect the principal until you sell your home, pass away, or move to another primary residence, such as a nursing home.
Depending on your age and the value of your home, a lender will offer you a variety of payment options. One option is to take a lump sum. You can also establish a line of credit you can draw on at will, or get fixed monthly payments as long as you stay in your home.
You can find reverse mortgages from many sources. The Federal Housing Administration (FHA) insures the most popular type of reverse mortgage, known as Home Equity Conversion Mortgages. They're offered through private lenders. Some large banks, such as Wells Fargo (NYSE: WFC ) and Bank of America (NYSE: BAC ) , offer them to borrowers across the country. Regional banks like Fifth Third (Nasdaq: FITB ) and M&T Bank (NYSE: MTB ) lend money within their respective business areas.
In addition to government-insured loans, some lenders have private proprietary reverse mortgage products. For instance, Fannie Mae (NYSE: FNM ) offers a reverse mortgage with limits that are higher than the FHA's in some locations.
Equity going backward
With reverse mortgages, money flows in the opposite direction from a typical mortgage -- your lender pays you. However, as the Motley Fool's Rule Your Retirement newsletter has discussed in detail, another aspect of home financing is also reversed: Rather than slowly gaining equity in your property, your equity is likely to go down over time with a reverse mortgage.
There are two reasons for this. First, if you take a monthly payment, then each month, you'll add to the outstanding balance of the loan. Second, as with any other loan, your lender will charge you interest on that balance. If your total loan balance grows faster than the value of your property -- which is certainly possible, especially with home prices falling dramatically in many parts of the country -- then you'll have less equity.
Traps for the unwary
While reverse mortgages can give you an easy way to get to your home's equity, you should understand a few things when considering them:
- Even if your home is paid off completely, you won't be able to borrow the full value of it. For instance, using a calculator from the National Reverse Mortgage Lenders Association website, a 62-year-old living in Houston would only qualify for a $125,000 loan on a home worth $200,000.
- Moreover, closing costs can be substantial -- well above what you'd pay on a typical mortgage. Using the same example, the calculator estimates fees and closing costs totaling over $16,500, leaving you with a lump sum of less than $108,500.
- In general, the older you are and the more your home is worth, the more you'll be able to get from a reverse mortgage. So if you wait until you really need a reverse mortgage, you'll often get better payouts.
- Similarly, don't take out more money than you need. Monthly payments or a line of credit that you draw from gradually will cost a lot less in interest than a lump sum.
Although you should keep these thoughts in mind, a reverse mortgage still might be a useful part of your financial plan for your retirement years. If you'd like to learn more, help yourself to a complimentary 30-day guest pass to Rule Your Retirement. You'll get access to back issues discussing reverse mortgages and much more. It's free, with no obligation to subscribe.
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