For older homeowners who own their homes outright or have small loan balances, a reverse mortgage might sound like an excellent way to supplement a lower income once they stop working. At age 62, baby boomers can take out a loan whereby the bank pays them a set amount each month until they die, sell the home, or move out for 12 consecutive months. Reverse mortgages can help older persons stay in their own house, using built-up equity to pay bills without having to sell their home.
But, there are risks. New rules have made these types of mortgages more difficult to obtain, but homeowners can still run into trouble with these specialized loans. Rules can be complicated, so here are a few things to consider before deciding if a reverse mortgage is right for you.
Eligibility rules are tougher. The most common reverse mortgage is called a Home Equity Conversion Mortgage, backed by the Federal Housing Administration. Because some borrowers, in years past, took their loan in a lump sum and then ran out of money, big payouts are now reduced by 10% to 18%. This encourages homeowners to opt for monthly payments, eliminating that particular risk.
They're expensive. Fees are high and plentiful with HECMs. You'll pay all the charges associated with a mortgage, such as appraisal, title search, and recording fees, as well as steep origination fees: For homes worth less than $125,000, for example, you might pay up to $2,500. Monthly servicing fees of $30 to $35 are common, and there is a charge for FHA mortgage insurance, as well.
All these fees and charges are added onto your loan balance, which also includes the interest on the unpaid balance. By taking out a reverse mortgage, be aware that you are actually adding to your loan debt.
You still own the home, and it can be foreclosed upon. If you neglect to pay property taxes or maintain the home, the debt may become due and payable immediately.
Age requirements can cause survivorship problems. Because homeowners must be 62 to take out a HECM – and get a bigger check if they are even older – some couples have been advised to take the younger spouse's name off of the deed. When the borrower dies, the spouse faces foreclosure if he or she cannot repay the loan. A lawsuit is pending regarding this issue, in which surviving spouses claim that the government did not adequately protect them from foreclosure.
Payments are considered part of a home's equity, and can be attached in a lawsuit. Although proceeds from a HECM are tax-free, and the payments don't impact benefits such as Social Security, a court in New Jersey has ruled that the monthly payouts can be used to pay a court judgment – since the payments represent the equity in the home, which could have been sold to satisfy the judgment.
Your heirs could get stuck with a mess. If you have children, be aware that a HECM might not only use up what might be considered their inheritance, but may pose additional problems when the lender demands payment in full, which occurs even though it is against federal regulations. Even if the lender agrees to settle with your heirs for a percentage, remember that the loan has been growing – and resolving the issue may create a real hardship for your children.
For some, reverse mortgages might be just what they need to utilize much-needed home equity during their later years. Like any financial undertaking, however, the decision requires due diligence and careful planning to make certain that the benefits outweigh the liabilities.