Is it worth taking a reverse mortgage?
A reverse mortgage turns home equity into cash – without moving out of your home. It can be a helpful funding tool for some retirees. But before you jump in, here are some things you should know about the potential downsides.
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What is a reverse mortgage?
A reverse mortgage is a loan against the equity in your home. Unlike a traditional mortgage, there is no sale of the house involved. The lender, that is, the mortgage holder, does not take ownership of your home on a reverse mortgage. Instead, your home will be used as collateral and you will be given cash. However, the lender receives an initial lien on your home. This means that when the house is sold, they have the right to repayment first.
You can get the money in several ways:
- Lump sum
- Monthly payment
- Line of credit that you can avail
- A combination of these
You can only get a reverse mortgage against your primary residence, and this type of mortgage is only available to senior homeowners who meet certain criteria.
How much can you borrow?
The amount you can borrow depends mainly on the age of the youngest borrower and the equity you have in the house. Current mortgage rates and your other financial obligations, including any ongoing mortgages, are also factors.
For a government-backed reverse mortgage (the most common type), the loan limit is the same as the loan limit for a single-family home in a high-cost area. In 2021, that limit is $ 822,375. The credit limits for government-sponsored reverse mortgages do not vary from one county to another.
When do you make payments?
You pay interest on a reverse mortgage as you would any other loan. Over time, and as you access more equity (in the form of monthly payments or drawdowns on your loan), your loan balance will grow. The interest that accumulates will also grow. After all, the loan balance will be much higher than the amount of money you received.
A reverse mortgage loan does not have to be paid back until you sell the home, move, or die. In many cases, paying back the loan means selling the house. However, if you or your heirs decide at an earlier stage that you want to pay off the loan, you have the option of doing so.
Once the house is sold and the loan is paid off and there is still equity, the money will be distributed to you (if you are alive) or to your estate (if you have died).
Where can I get a reverse mortgage?
You can get a single-purpose reverse mortgage from a state or local agency. In this case, the lender stipulates that the loan can only be used for a specific purpose – for example, to help you pay your property taxes. This type of reverse mortgage is intended for low and middle income borrowers.
Private lenders also offer certain reverse mortgages. These are called own loans, and each lender sets their own terms and conditions. You may be able to get more credit with this type of loan and there are usually no restrictions on how the money can be used.
Most reverse mortgages are Home Equity Conversion Mortgage (HECM) loans that are insured by the federal government. This loan is available from FHA lenders. There is no limit to how you use the money.
Possible disadvantages of a reverse mortgage
Here are some factors that you should consider before getting a reverse mortgage.
- Variable rate: Most reverse mortgages are not fixed rate loans. Instead, like some credit cards and home equity products, they have floating rates. The interest rate changes along with a reference rate chosen by the lender. Your rate can go up or down and that is out of your control.
- Upfront costs: You pay a creation fee, an evaluation fee, and other closing costs, as well as mortgage insurance premiums. You may be able to add these costs to the loan balance, but if so, start with a sizeable sum of money on the first day.
- Other editions: A reverse mortgage is a loan, not a sale. You remain the homeowner, and that means you are responsible for all utilities, maintenance, property taxes, insurance, and other home costs.
- No tax advantage: The interest on a reverse mortgage is generally not tax deductible.
- Credit Limits: Government-secured loans are subject to the current credit limits. Also, lenders have their own limits – they won’t loan you 100% of your equity. Because the final sales price has to cover interest and borrowing costs.
When a reverse mortgage could be a bad idea
Relatively young homeowners should make a careful decision about a reverse mortgage loan. You must be at least 62 years old to qualify, but even that may be too young for some. If you outgrow your repayment term and cannot repay the debt, you can lose your home and have to move.
A reverse mortgage can also be a bad idea if leaving more wealth to your heirs is important to you. The credit balance, including interest, might leave little to nothing for them to inherit from that particular asset.
Older homeowners can often qualify for a larger loan, but be careful not to take out the loan in your name unless you are married, especially if your spouse is much younger. If the loan is an HECM, a qualified surviving spouse can remain in the home. The prerequisite for this is that the spouses were married at the time the loan was signed and that they meet other criteria. Even if the surviving spouse is allowed to stay in the home, the lender will no longer release money and the loan will not have to be repaid until the surviving spouse moves, sold, or dies. With other types of reverse mortgage loan, if the borrower dies, the lender can call the loan due, forcing the surviving spouse to move.
Other adults in the household are usually not protected. Adult children or other household members must either repay the loan or move.
After all, it could be a risky move if there is a chance that you are struggling financially despite the loan. You are still responsible for property taxes, home insurance, and other expenses. If you don’t keep up, you can lose your home.
Who Should Get a Reverse Mortgage?
A reverse mortgage can help you turn your greatest financial fortune into monthly income. If you meet these criteria, a reverse mortgage may be a viable option:
- You have a lot of equity in your home or it is paid off
- You want or need more money every month
- You don’t expect to live in the home for longer than the repayment term
- You agree to reduce the value of the assets you leave behind after death
Reverse mortgages have their value in the right circumstances. Just do some research on how a reverse mortgage will affect your finances – and your family – before you sign on the dotted line.