If you’re a homeowner age 62 or older, the idea of borrowing against your home with a reverse mortgage may have crossed your mind. After all, you may have seen Tom Selleck, Henry “The Fonz” Winkler or maybe even a couple of Law & Order actors on TV, assuring you that taking out a reverse mortgage on the equity in your home could create more retirement income.
With a reverse mortgage, the homeowner borrows against their home equity, and the lender makes payments to the homeowner – instead of the other way around. That may sound like a sweet deal, but the reverse mortgage industry has a shady past for luring naive homeowners into bad financial situations they couldn’t afford or didn’t fully understand.
Today, more consumer protections are in place to keep borrowers from getting in over their heads financially. Still, a homeowner considering taking out a reverse mortgage should proceed carefully – or sometimes, back away completely – when it comes to a reverse mortgage.
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As individuals reach retirement age, they often face the challenge of managing their finances and maintaining their standard of living. One innovative financial tool that has gained popularity in recent years is the reverse mortgage.
How Reverse Mortgages Work
Reverse mortgages work by using the equity in a home to provide homeowners with a steady stream of income or a lump sum payment. The loan is repaid when the homeowner sells the property, moves out of the home, or passes away. The amount of money available through a reverse mortgage is determined by several factors, including the appraised value of the home, the borrower’s age, and current interest rates.
There are three types of reverse mortgages
There are different types of reverse mortgages available to borrowers. The most common type is the Home Equity Conversion Mortgage (HECM), which is insured by the Federal Housing Administration (FHA). Other options include proprietary reverse mortgages, which are privately insured, and single-purpose reverse mortgages, which are usually offered by state or local government agencies.
When deciding on a reverse mortgage, you’ll want to choose the type that best suits your needs. The least expensive option, a “single-purpose” reverse mortgage, is offered by some state and local government agencies. A single-purpose loan can only be used for one purpose specified by the lender, such as home repairs, improvements or property taxes.
Proprietary reverse mortgages are private loans, which are backed by the companies that develop them. If you have an expensive home, you may be able to get a larger loan advance with this type of reverse mortgage, according to the Federal Trade Commission (FTC).
Most reverse mortgages are Home Equity Conversion Mortgages (HECM), which are insured by the Federal Housing Administration (FHA) and backed by the U.S. Department of Housing and Urban Development (HUD).
You’ll pay fees and other costs
Reverse mortgage lenders typically charge an origination fee and other closing costs in addition to servicing fees over the life of the mortgage. Federally insured HECMs may also charge mortgage insurance premiums. You’re also not allowed to deduct interest charged on the reverse mortgage loan on your income taxes, at least not until the loan is paid off either partially or in full, according to the Federal Trade Commission (FTC).
Reverse mortgage loans must be repaid when you die
When it comes to repaying a reverse mortgage, homeowners have various options. They can choose to make regular payments towards the loan, pay it off in full, or allow the lender to sell the property to repay the loan. It’s essential to carefully consider these options and select the one that best fits the homeowner’s financial situation and goals.
If you’re the borrower, you, your spouse or your estate won’t have to repay the loan for as long as you live in the home or until you die. Once you’re deceased, however, the loan must be paid.
“If you have a Home Equity Conversion Mortgage (HECM) your heirs will have to repay either the full loan balance or 95% of the home’s appraised value – whichever is less,” according to the Consumer Financial Protection Bureau (CFPB). The loan becomes due and payable upon the death of the borrower, and your heirs have 30 days from receipt of the due and payable notice to buy the home, sell the home, or turn the home over to the lender to satisfy the debt.
“With a reverse mortgage loan, if the balance is more than the home is worth, your heirs don’t have to pay the difference,” says the CFPB. “If your heirs sell the home, the lender will take the proceeds from the sale as payment on the loan, and the FHA insurance will cover any remaining loan balance.”
Qualifications and Eligibility
You must be at least 62 years old and live in the home
To qualify for a reverse mortgage, also known as a Home Equity Conversion Mortgage (HECM), you must be at least 62 years old and reside in the home as your primary residence.
You must also either own the property outright or have paid down your mortgage considerably so that you have a good amount of equity in the home. Then the reverse mortgage lender converts part of the equity in your home into tax-free payments made to you.
You must prove adequate financial resources
When you apply for a reverse mortgage, the lender is required to perform a financial assessment and may even require an amount from the loan to be set aside to pay taxes and insurance for the home during the loan. The “set-aside” will reduce the amount of funds you receive in payments. Meanwhile, you are also responsible for maintaining upkeep on your home.
You must meet with a counselor first
Before you can apply for a HECM reverse mortgage, you must first meet with a counselor from an independent government-approved housing counseling agency. The counselor will explain the reverse mortgage loan’s costs and financial implications. But the counselor must also tell you about possible alternatives to a HECM reverse mortgage such as government and nonprofit programs or a single-purpose or proprietary reverse mortgage.
The housing counselor can help compare costs for different types of reverse mortgages and show you how different payment options, fees and other loan costs will add up over time. To find a reverse mortgage counselor, search the HECM counseling agency directory at hud.gov or call 800-569-4287.
Pros and Cons of Reverse Mortgages
Reverse mortgages offer several advantages, such as providing additional income in retirement, allowing homeowners to stay in their homes, and offering flexibility in accessing funds. However, there are also some considerations to keep in mind. These include potential costs and fees associated with reverse mortgages, the impact on inheritance, and the need for careful financial planning to ensure the funds are used wisely.
Safeguards and Consumer Protections
To protect homeowners, reverse mortgages are subject to various safeguards and consumer protections. These include mandatory counseling to ensure borrowers understand the terms of the loan, limits on the amount that can be borrowed, and requirements for lenders to provide clear and accurate information about the costs and risks associated with reverse mortgages.
Impact on Heirs and Estate
One common concern regarding reverse mortgages is the impact on heirs and the borrower’s estate. Upon the borrower’s passing, the loan becomes due, and the heirs have several options. They can choose to sell the property to repay the loan, refinance the loan, or repay the loan with other assets. It’s important for borrowers to discuss their plans with their heirs to ensure everyone is aware of the implications and potential outcomes.
Reverse mortgages may have tax implications that borrowers should be aware of. Generally, the funds received from a reverse mortgage are not considered taxable income. However, interest accrued on the loan is not deductible until it is paid. It’s recommended to consult with a tax advisor to understand the specific tax implications based on individual circumstances.
Frequently Asked Questions (FAQs)
Q:Can I lose my home with a reverse mortgage?
Q:How much money can I receive through a reverse mortgage?
Q:Are there any upfront costs associated with reverse mortgages?
Q:Can I refinance a reverse mortgage?
Q:Will a reverse mortgage affect my Social Security or Medicare benefits?
Reverse mortgages can be a valuable financial tool for seniors looking to unlock the value of their homes in retirement. By converting home equity into usable funds, homeowners can supplement their income, cover expenses, and enjoy a comfortable retirement. However, it is crucial to carefully consider the pros and cons, eligibility requirements, and repayment options before making a decision. With proper research and guidance, seniors can make informed choices that align with their financial goals and aspirations.
Connect with a certified credit counselor to review your options.
Article last modified on July 14, 2023. Published by Debt.com, LLC