It's the middle of the night, and you can't sleep. You switch on the TV, and there it is: a celebrity in a commercial pitching you a reverse mortgage.
You may have seen Henry Winkler, Robert Wagner, Pat Boone, or some other star touting reverse mortgages as a solution for seniors who need money. But just because a famous face is saying so doesn't mean a reverse mortgage is right for you.
Reverse mortgages are complex financial products that come with potential advantages, as well as costs and risks.
So before a celeb gets you sold on a reverse mortgage, learn more.
What is a reverse mortgage?
A reverse mortgage is an interest-bearing loan secured by the equity in your home. it's available to homeowners aged 62 and above.
For a senior in need of cash, a reverse mortgage might provide an alternative to selling a home or taking out a conventional home equity loan. Proceeds can be used to supplement retirement income, pay off debt, or meet other obligations.
"Borrowers have the freedom to use their cash proceeds any way they choose, without restrictions," said Peter Bell, president of the National Reverse Mortgage Lenders Association, an industry trade group.
Unlike a standard mortgage, where you make payments to a bank, with a reverse mortgage, the bank "pays" you, in the form of funds from your reverse mortgage loan. Borrowers generally don't make any interest or principal payments during the life of the loan.
Typically, the older you are, and the more equity you have in your home, the more you can borrow. The money can be doled out in a lump sum, in periodic payments, or in the form of a credit line. The loan proceeds are generally tax-free.
What about my other home-related expenses?
You're still on the hook. While you don't have to make mortgage payments until the reverse mortgage loan matures, you must remain current on your real estate taxes, homeowners insurance, and other obligations, such as homeowner association fees. You're also responsible for keeping your home in good condition.
Before you take out a reverse mortgage, it's important to think about whether you have the financial resources to keep up these obligations. If you fail to do so, your lender could foreclose on your property.
"You could lose your home," said Lori Trawinski, director of banking and finance at the AARP Public Policy Institute.
Who is eligible to take out a reverse mortgage?
You must be at least 62 and own your home outright. If there's any existing mortgage on your home, it must be paid off. Proceeds of the reverse mortgage can be used to pay off your existing mortgage.
In addition, your home must be your primary residence. Vacation homes and investment properties are not eligible.
When is the loan due, and what will I owe?
Generally speaking, the loan doesn't have to be repaid until the last surviving borrower dies, sells the house, or leaves the home for more than 12 months, which might happen if a senior were to enter an assisted-living facility. The proceeds from the sale of the home are generally used to pay back the loans.
Keep in mind that when the time comes to repay the lender, the balance will equal the amount of money you borrowed -- plus the accrued interest and mortgage insurance.
You might think of a reverse mortgage as the opposite of a traditional home loan. A standard mortgage gradually gets smaller as you make payments. With a reverse mortgage, you don't make payments during the life of the loan, but the amount you owe grows over time, which is why reverse mortgages are often called "rising debt" loans.
What types of reverse mortgages are available?
The vast majority of reverse mortgages are Home Equity Conversion Mortgages (HECMs). These are loans issued by a private lender and insured by the Federal Housing Administration.
The insurance guarantees that you'll continue to get your payments even if your lender goes out of business. It also protects the lender in the event that the value of your home, when it's sold, isn't enough to cover what's owed on the loan.
HECMs are non-recourse loans. That means if your home is sold for less than what you owe, the lender can't come after any other assets owned by you or your heirs.
The federal insurance protection comes at a price. Borrowers who choose HECMs are charged an annual insurance fee of 1.25% of the loan balance.
There are also restrictions associated with HECMs. In recent years, new government rules have gone into effect to protect seniors, including one that limits most borrowers to taking only 60% of a loan in the first year.
Prospective borrowers are also required to meet with reverse mortgage counselors to learn about the financial implications of the loan and alternatives to taking out a HECM.
Some state governments, local governments, and non-profits offer another type of reverse mortgage called a single purpose reverse mortgage. These loans are generally for low- to moderate-income homeowners, and the proceeds must be used for a particular purpose determined by the lender. Single purpose reverse mortgages are not federally insured.
A third type of reverse mortgage, a proprietary reverse mortgage, is generally for people who have homes with high values. They are not federally insured.
What about my heirs?
They could be out of luck.
Reverse mortgages can eat up the equity in your home, which means fewer assets to leave behind for your children. If you want to leave your home to your heirs, a reverse mortgage is generally not the right choice.
What are the costs?
There are a number of fees, including mortgage insurance premiums, closing costs, origination fees, and servicing fees. All told, these fees can add thousands of dollars to the cost of your loan.
Generally, you don't pay these costs up front, but they will reduce the net loan amount available to you.
What's the bottom line?
Tapping into the equity in your home through a reverse mortgage is a serious financial decision.
As you think about whether this type of loan is right for you, consider your health, your spouse's health, and whether there are alternative sources of income you might tap first.
Speak to an expert about how a reverse mortgage fits into your overall retirement plan.
"Contact an elder law attorney or financial professional," Trawinski advised. "The key is to seek out unbiased advice."
If you choose to take out a reverse mortgage, be sure to use the money wisely. Just because you don't have to pay the loan back as long as you live in your home, doesn't mean you should treat it as "mad money."
"Some lenders market reverse mortgages to younger retirees as a way to finance a more extravagant retirement lifestyle than they could otherwise afford," the Financial Industry Regulatory Authority warns in an investor alert. "The trouble is, those same homeowners may need their home equity some day for something far more pressing than a vacation, only to find that it has already been spent."
Think twice about anyone who encourages you take out a reverse mortgage to fund luxury purchases or risky investments. Making the wrong decision could mean many more sleepless nights ahead.