Millions of retirees face the financial challenge of making ends meet, and for many of them, the equity they have in their homes is their largest untapped asset. Yet many retirees don't want to make the dramatic decision to sell their family home in order to free up the home equity they've built up over the years, preferring instead to stay where they are and consider alternative ways to gain access to much-needed cash. In that vein, reverse mortgages promise to give retirees an easy way to pull out their home equity, but there are several technicalities that you should understand before considering a reverse mortgage. Let's take a closer look at what reverse mortgages are and whether they're right for you.
What a reverse mortgage is
One of the biggest confusions about reverse mortgages is the terminology involved. In its most traditional form, a reverse mortgage involves making an arrangement with a lender whereby the lender makes monthly payments to you. But reverse mortgages have several different payment arrangements. One allows you to take payments for as long as you're alive and remain in the home. Others let you take payments for a fixed number of years, in a lump sum, or at the future time of your choosing through a line of credit. Which option you choose will affect how much you're able to borrow, but in general, the percentage of your home equity that you're allowed to tap will be higher for older retirees and lower for those at or near the minimum required age of 62.
The Federal Housing Administration runs a government-insured reverse mortgage program that uses private lenders to extend reverse mortgage loans. The primary benefit of FHA reverse mortgages is that as long as the reverse-mortgage borrower remains in the home as a principal residence, the loan won't come due. Only after the borrower dies, sells the home, or moves elsewhere does the reverse mortgage immediately become due. Moreover, if the loan amount outstanding exceeds the value of the home, then the government is on the hook to cover the difference, protecting the lender and making sure that the lender won't come after you for any shortfall.
The costs of a reverse mortgage
The benefits of reverse mortgages come at a price, though. Initially, you'll pay between 0.5% and 2.5% of your loan amount as a mortgage insurance premium, and every year, you'll pay another 1.25% of the outstanding mortgage balance to cover insurance costs. In addition, lenders are eligible to charge origination fees of as much as $6,000, with charges of up to $2,500 for the first $125,000 of value, 2% of the next $75,000, and 1% of the value above $200,000 subject to the overall maximum. Finally, monthly servicing fees can add $30 to $35 to the cost of a reverse mortgage.
To make things easier for retirees, the FHA often allows you to incorporate these costs into the total amount of the loan. That means you don't have to pay them out of pocket, but they also reduce the amount that's available to you to borrow or receive in monthly payments.
The surprise "gotcha" with reverse mortgages
One confusing aspect of reverse mortgages that trips up unsuspecting families is the requirement that the borrower live in the home. When married couples are both listed as borrowers on a reverse mortgage, their joint life expectancies can result in reduced payments. To boost their payment amounts, some homeowners choose to list just one family member on the reverse mortgage.
That strategy can backfire if the borrower has a medical condition that requires long-term care outside the home. In some cases, the borrower's spouse will find that the reverse mortgage comes due immediately because the borrower no longer can treat the family home as a primary residence, and the spouse will therefore have to move out if the loan can't be repaid.
The solution is simply to list both spouses on the reverse mortgage and accept the lower benefits that come with it. The peace of mind of knowing that the loan can't come due as long as either one of the named spouses lives in the home can outweigh any financial reduction in payments.
You can find more information about reverse mortgages from the websites of the government agencies that oversee them. The Department of Housing and Urban Development has information on reverse mortgages here, and you can see the answers to many frequently asked questions about reverse mortgage on this web page.
Reverse mortgages can be complicated, but they also offer a unique way to tap your home equity in a way that's consistent with the typical retiree's lifestyle. As long as you're aware of the potential pitfalls, a reverse mortgage can be a great solution for your liquidity needs while letting you stay in your home as long as you like.