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Is a Reverse Mortgage a Good Strategy in This Economy?

If you’re a homeowner nearing retirement age, you’ve probably seen the TV commercials about reverse mortgages. Tom Selleck offers a friendly explanation of reverse mortgages and how people use them. How accurate is what he and other proponents of reverse mortgages indicate? Are reverse mortgages actually a good strategy to help fund your retirement?

How Does a Reverse Mortgage Work?

The most common type of reverse mortgage is called a Home Equity Conversion Mortgage (HECM). A HECM is the only reverse mortgage program insured by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development (HUD). HECM loan amounts are based on borrower age, home value, and current interest rates.

HECMs and other reverse mortgage products work similarly to a regular mortgage, with closing costs, interest rates, and mortgage insurance — but instead of making payments, you receive payments from your home’s equity to help supplement your retirement income.

Who Can Get a Reverse Mortgage?

If you’re over 62, own your home, and have significant equity in your home, you may be eligible for a reverse mortgage. Some proprietary reverse mortgage products are available for people as young as 55 in some states. Even if you have an existing traditional mortgage (sometimes called a forward mortgage), where you make a payment each month, if you have significant equity in your home you can obtain a reverse mortgage, and the first thing the reverse mortgage loan amount will be used for is to pay off the existing mortgage so that you no longer have to make monthly mortgage payments, thereby immediately increasing your monthly income by the amount of your paid-off mortgage payment.

When you take out a traditional mortgage loan, you’re borrowing a lump sum from the lender; the lender gives you that lump sum immediately (you typically never personally receive the loan because it goes directly at settlement to purchase your home), and you have to start paying it back, with interest, starting the following month and continuing for the term of a mortgage loan, typically between 15 years and 30 years. At the end of the term, the loan is paid down to $0.

A reverse mortgage works in reverse. Depending on the reverse mortgage program, you can get payments via a line of credit, a lump sum, monthly payments over a set term (sometimes along with a line of credit), or tenure payments for the rest of your life. There are also combinations of these options that get more complicated, but these five main options are explained in more detail below.

Types of Reverse Mortgages

1. Line of credit

Most people who get a reverse mortgage get a reverse mortgage with a line of credit payment plan, which has an adjustable interest rate. This payment plan provides the most potential of growing your retirement income, depending on how you use your credit. In general, you can access up to 60 percent of your principal limit in the first year. In the second year and beyond, you gain access to the remaining 40 percent as well as whatever you didn’t use in the first year. Your available line of credit only decreases if and when you use it, and the interest and mortgage insurance that you have to pay will only be owed for the money that you actually borrow from the line of credit.

2. Fixed-rate lump sum

The fixed-rate lump-sum payment plan is the only type of reverse mortgage that has a fixed interest rate. When you get this type of reverse mortgage, you must take out the entire loan amount all at once, at closing. This option might be the best if you are using most or all of the proceeds from the reverse mortgage to pay off your existing traditional mortgage.

If you’re not using the proceeds to pay off your existing mortgage, then it’s very important that you create a strong financial plan to manage the large sum that you will be receiving all at once.

3. Term reverse mortgage

With a term reverse mortgage payment plan, you get equal monthly payments until you have reached the loan’s principal limit. If you outlive your loan, you can still stay in your home as long as you meet the loan obligations (paying property taxes and homeowner’s insurance, keeping the home in good shape), but you won’t be able to get any more loan proceeds.

4. Modified term reverse mortgage

A modified term reverse mortgage allows you to receive your proceeds as a fixed monthly payment for a certain number of months and allows you to still have a line of credit that you can use to take out additional funds if and when needed.

5. Tenure reverse mortgage

Tenure payment plans provide equal monthly payments until you die, as long as at least one borrower uses the home as their primary residence. This type of payment plan is great if you think you might live a long time, and you are worried that you may run out of money. But the downside, of course, is that the monthly payment will be less than under the prior payment plans.

The interest and fees associated with the reverse mortgage loan get rolled into the balance each month. That means the amount you owe grows over time, so your home equity generally decreases over time (assuming the value of your home stays the same). You get to keep the title to your home the whole time, just as you do with a regular mortgage. The balance of the reverse mortgage isn’t due until one of the following triggering events occurs:

1. you sell the property;
2. you die;
3. you’re away from the home for more than six consecutive months for a nonmedical reason; or
4. you’re away from the home for more than 12 consecutive months in a medical facility, such as a nursing home.

To avoid default, you must keep up with your property taxes as well as your homeowner’s insurance.

When one of the triggering events occurs, the home must be sold, and proceeds from the home’s sale are used to pay off the balance of the reverse mortgage. If there’s any equity left over, it goes to you or to your estate. If you wind up having the reverse mortgage for quite a long time, and the loan balance at the time of the triggering event is more than the value of the home, your heirs are never required to pay the difference; the lender has no recourse against your heirs, which is why a reverse mortgage loan is a “no recourse loan.” Heirs also can choose to pay off the reverse mortgage or refinance if they want to keep the property.

Can Anyone Take Out a Reverse Mortgage Loan?

As mentioned earlier, reverse mortgages are generally available to homeowners who are 62 and older, though some reverse mortgage products are available to people as young as 55 in some states. Aside from age, other reverse mortgage requirements include:

Your home must be your principal residence, meaning you live there the majority of the year.
You must own your home free and clear of any mortgage or have an existing mortgage balance low enough that the reverse mortgage loan can pay it off.
You cannot owe any federal debt, such as federal income taxes or federal student loans. You may, however, use money from the reverse mortgage loan to pay off this type of debt.
You must have enough monthly income, or agree to set aside part of the reverse mortgage funds at your loan closing, to pay ongoing property charges, including taxes and insurance, as well as maintenance and repair costs.
Your home must be in good shape. If your home does not meet the required property standards, the lender will tell you what repairs need to be made before you can get a reverse mortgage loan.
In general, you (or your agent under power of attorney) must receive counseling from a HUD-approved reverse mortgage counseling agency to discuss your eligibility, the financial implications of the loan, and other alternatives.

Is a Reverse Mortgage the Best Option for You?

Reverse Mortgage loans can sound pretty appealing, especially if most of your net worth is tied up in your home. However, there are pros and cons to all financial decisions. Surprising to some, AARP research indicates that reverse mortgage borrowers are almost always happy that they obtained a reverse mortgage. Findings are as follows:

94 percent of borrowers feel that a reverse mortgage has given them peace of mind;
89 percent say that they have a more comfortable lifestyle with the reverse mortgage loan;
87 percent feel that the reverse mortgage loan improved their quality of life.

But there are some definite downsides, too. If you’ve been considering this type of loan, first make sure to weigh all the pros and cons of a reverse mortgage before you sign on the dotted line.

Reverse Mortgage Pros and Cons — Do the Advantages Outweigh the Disadvantages?

Advantages of a Reverse Mortgage

The main advantage of reverse mortgages is that you can eliminate your traditional mortgage payments and/or access your home equity while still owning and living in your home for the rest of your life. Given the right set of circumstances, a reverse mortgage can be an ideal way to increase your spending power and financial security in retirement. If you want to age in place and need in-home care in order to remain at home, and if you have run out of financial assets and don’t have enough monthly income to pay for the required in-home care, a reverse mortgage is often the only way to stay in your home.

Advantages of reverse mortgages include:

Reverse mortgages are flexible and can be utilized in a variety of ways for a variety of different types of borrowers.
You can stay in your home and immediately improve your monthly cash flow.
Unlike a home equity loan or home equity line of credit, with a reverse mortgage, your home can’t be taken from you for reasons of nonpayment. However, as mentioned, you must continue to pay for upkeep and taxes and insurance on your home.
With a reverse mortgage line of credit, the principal limit, loan balance, and available line of credit grow at the same rate throughout the duration of the loan, regardless of changes in your home’s value. This means that the longer you have your reverse mortgage in place, the more money you will have available to borrow, even if the value of your home decreases.
Reverse mortgage lenders have no claim on your income or other assets, nor can they go after the income or assets of your heirs or beneficiaries.
Neither you nor your estate will ever owe more than your home’s value at the time the loan is repaid, even if the reverse mortgage lender has paid you more money than the value of the home. This is a particularly useful advantage if you secure a reverse mortgage and then home prices decline, or if you stay in your home for many years after obtaining the reverse mortgage and use up the entirety of the reverse mortgage loan amount.
As a reverse mortgage is a loan, the money you receive from it is tax-free, whether you receive it as fixed income or in a lump sum.
Also, having a reverse mortgage will not affect your ability to obtain in-home Medicaid benefits, even if you are withdrawing monthly payments from the reverse mortgage line of credit, so long as those monthly withdrawals are spent during the same month that they are withdrawn.
The HECM is insured by the Federal Housing Administration (FHA). This is important because even if your lender defaults, you’ll still receive your payments.
Depending on your circumstances, there are a variety of ways that a reverse mortgage can help you preserve your wealth.
If you’re struggling to meet your financial obligations, a reverse mortgage may help you stay afloat.
How you use the funds from a reverse mortgage is entirely up to you!

Disadvantages of Reverse Mortgages

So, what is the downside of a reverse mortgage? Though there are many benefits, there are also some downsides to consider.

The first major downside right now is how high mortgage rates have made it difficult for industry pros to connect with new and existing borrowers. People are not refinancing as they were in past years, and high rates are deterring prospective customers.
The upfront fees (closing and insurance costs and origination fees) for a reverse mortgage are considered by many to be somewhat high – often higher than the costs charged for refinancing a traditional mortgage, for example. However, similar to other mortgage loans, the fees can be rolled into the reverse mortgage itself, so there are options to avoid “out-of-pocket” expenses at closing.
There are no monthly mortgage payments on a reverse mortgage. However, you must continue to pay property taxes and homeowner’s insurance, maintain the property, and otherwise comply with the loan terms.
If you have a lot of home equity, you might be frustrated that a reverse mortgage only enables you to use some of it. The HECM loan limit is currently set at $970,800. For some proprietary reverse mortgage products, the maximum loan amount is higher. This means that the amount you can borrow is based on this maximum value even if your home is valued for more. Your actual loan amount is determined by a calculation that uses the appraised value of your home, the amount of money you owe on the home, your age, and current interest rates.
You could lose your home to foreclosure. In order to qualify for a reverse mortgage, you have to be able to afford your property taxes, homeowner’s insurance, and other costs associated with owning your home. You’re also required to live inside the home as your principal residence for over six months of the year. If at any point during the loan period you become delinquent on these expenses or spend the majority of the year living outside the property, you could default on the reverse mortgage and lose your home to foreclosure.
Your heirs could inherit less, or nothing, from the value of your home. A reverse mortgage usually requires the home to be sold after your death to repay the debt (unless there are sufficient other funds available in your estate to pay off the loan, or your heirs or beneficiaries have enough money of their own to pay off the loan). However, if there is no equity left in the home upon your death, your heirs/beneficiaries can simply walk away from the home and the loan and let the lender foreclose.

Should You Get a Reverse Mortgage?

A reverse mortgage is helpful for many people and essential for people who want to live at home with in-home care and have no other means to pay for that care. But a reverse mortgage of course is not a good idea for everyone. Ultimately, the decision to take out a reverse mortgage is one you should weigh carefully with the help of your Elder Law attorney and financial advisor. Though it’s an easy way to get cash, it could put your finances at more risk in the long run and could eventually leave your heirs with a lot less if that matters to you.

Reverse Mortgages Do Not Affect Medicaid Eligibility

As mentioned above, please keep in mind that if you should need nursing home level care in the future (either at home or in a nursing home), a reverse mortgage does not affect Medicaid eligibility. Keeping money in a reverse mortgage line of credit does NOT count as a resource for Medicaid eligibility purposes, so long as the house itself is an exempt resource, which it is so long as you’re living in it; and in some states, the home is also temporarily exempt if you go into a nursing home. However, transferring money from a reverse mortgage line of credit to a bank account and leaving it there past the end of the month would generally convert the exempt home equity into a countable resource and that could make you lose your Medicaid eligibility. For more details on the advantages and disadvantages of reverse mortgages, please read our articles on the subject here.

Planning for Long-Term Care

If you or your loved one is facing the possible need for long-term care and/or thinking about getting a reverse mortgage, you should get an opinion from an experienced Elder Law attorney who is also experienced with reverse mortgages, such as myself, before moving forward. Please call us to make an appointment:

Fairfax Elder Law: 703-691-1888
Fredericksburg Elder Law: 540-479-1435
Rockville Elder Law: 301-519-8041
DC Elder Law: 202-587-2797

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About Evan H Farr, CELA, CAP

Evan H. Farr is a 4-time Best-Selling author in the field of Elder Law and Estate Planning. In addition to being one of approximately 500 Certified Elder Law Attorneys in the Country, Evan is one of approximately 100 members of the Council of Advanced Practitioners of the National Academy of Elder Law Attorneys and is a Charter Member of the Academy of Special Needs Planners.

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