Like so many Americans, you may be fretting about retirement and how you're going to support yourself for all those years. Even if you've been investing diligently for years, you may fear that you don't have enough. There's a certain fund-generating strategy you might want to consider: the reverse mortgage. It can sound like a perfect solution, but don't jump into it without learning more first.
In a nutshell
What's so great about a reverse mortgage? Well, it can give you a bundle of money to live on in retirement. There are a few strings attached, though, and many details to understand.
You're probably familiar with how mortgages work. You borrow money from a lender in order to buy a house, putting a certain percentage down first. The lender agrees and charges you interest and holds the house itself as collateral. With a reverse mortgage, you receive regular payments based on the value of your home, and you get to stay in your home, too. The "reverse" nature of this structure means that the lender makes monthly mortgage payments to you, instead of the other way around, and at the end of the term, or when you no longer live in the home, the lender will be repaid, often through a sale of the home.
Reverse mortgages are available to those who are aged 62 and older and own their homes entirely or owe very little on them. Per the National Reverse Mortgage Lenders Association (NRMLA), the size of the income stream you can expect is based on a handful of factors, such as:
- Your age -- or, if you're applying as a couple, the age of the younger partner
- The value of the home (which should be your primary residence, too)
- The interest rate
You're essentially borrowing money from a lender as you collect your checks, and the loan doesn't have to be repaid until 1) you stop living in the home, 2) you sell the home, or 3) you die. (Payment is generally due in full when you die or within 12 months of when you or your surviving spouse last lived in the home.) The income you receive is typically tax-free, too.
Three main kinds
There are three main kinds of reverse mortgages. The vast majority -- about 90% -- are Federally insured home equity conversion mortgages (HECMs), backed by the U.S. Department of Housing and Urban Development (HUD). The other kinds are proprietary reverse mortgages, which are private loans and single-purpose reverse mortgages. These reverse mortgages are offered by some state and local government agencies and nonprofit organizations and are generally intended to help lower-income folks pay for a single expense such as a home improvement.
To get a very rough idea of what one might get with a reverse mortgage, here are some results from the National Reverse Mortgage Lenders Association's online calculator: A 70-year-old couple in Colorado with a home valued at $300,000 and a loan principal of $172,800 might get a lump sum of about $94,000 via a fixed-rate reverse mortgage or monthly checks of $973 via an adjustable-rate one. What you might get could be very different, though, based on lots of factors, such as your age and the home's value.
Proceed with caution
Though a reverse mortgage might sound like a perfect solution to your income needs, there are some drawbacks to consider. For starters, just like regular mortgages, reverse mortgages have closing costs -- and they tend to be higher. For HECM loans, for example, origination fees are generally 2% of the value of the loan.The applicable interest rates tend to be higher as well, in part because a mortgage insurance charge (generally between 0.5% and 2.5%) is added to the rate. Receiving income from a reverse mortgage may also affect your eligibility for various benefits, such as Medicaid and Supplemental Security Income.
Know, too, that if you have a reverse mortgage on your home, you'll still be responsible for property taxes, home insurance, utility bills, maintenance, and repairs.
A major potential downside is that a reverse mortgage will shrink the value of your estate, meaning that you'll have less wealth to pass on to your loved ones. If your kids and others are in good financial shape, this may not be much of a concern, but many people are counting on leaving little windfalls to their survivors.
There are more details to consider and more complexities to reverse mortgages. That's why with HECMs, it's required that borrowers receive counseling from an HUD-approved housing counseling agency, in part to discuss alternatives. That's a fine idea, too, because sometimes people are subjected to high-pressure sales tactics by agents who aren't looking out for their best interests. The elderly are frequent targets, and they're not always equipped to evaluate the product. It's often smart for younger friends or family members to get involved and assess the situation and any reverse-mortgage proposal.
Reverse mortgages aren't right for many people, but they do serve some people well. Before getting one, take time to learn more about them, explore all your options, and consult with a financial advisor or two.