For seniors who own their own home — fully paid off or with a small remaining mortgage — but need more income, a reverse mortgage can be the perfect solution. Or it can be a costly mistake. And you won’t know until you consider all the costs as well as your likely future housing needs.
Here are some key details on how reverse mortgages work:
—You can withdraw either a lump sum, use a line of credit, or receive monthly payments — tax free — out of the equity you have built up on your home.
—Most importantly, you can never run out of money or home equity, or be forced out of your home because of those withdrawals.
—When you sell your home or die, the amount you have withdrawn plus interest and fees, is taken out of the proceeds, with the balance going back to you or your heirs. If no equity is left, neither you nor your heirs owe any money.
—The standard home-equity conversion mortgage (HECM) is available to homeowners age 62 or older who have either paid off their mortgage or have a small remaining balance. The reverse mortgage is first used to pay off the mortgage balance.
—The amount you can receive is determined by your age, the value of your home and current interest rates. The older you are, the more money you get!
—You don’t need a credit check to qualify, and you retain title to your home.
—You remain responsible for property taxes, insurance and general upkeep of the home. So the lender will want to see evidence that you have enough ongoing income to do that.
—You must have independent counseling from an independent HUD-certified housing counselor before a reverse mortgage will be granted.
Other considerations
Basically, it’s that simple. Your house will become your piggy bank pension for tax-free withdrawals in your retirement. But there are some other things to think about before taking on a reverse mortgage:
—How long will you really stay in your home? At a minimum, the answer should be five years, but it’s better if your time horizon is 10 years. That’s because there are significant fees to set up a reverse mortgage, which are built into your line of credit. It’s just not worth it if you won’t be able to keep up with rising property taxes or might need assisted living in the near horizon.
—Would you be better off selling your home now, in a rising price environment, and banking the cash — or using it to move into a continuing care community, where your future health needs can be accommodated? It’s a tough call to leave the family home, but better to make that decision while you have flexibility.
—Can you manage the lump sum? Almost all reverse mortgages these days give a lump sum or line of credit, which you can use to repair the roof or replace the furnace or maintain your lifestyle. But since very few reverse mortgages now offer lifetime monthly payments, you might find yourself forced to move when the line of credit runs out!
Comparing lenders
Once you’ve thought through the implications for your own future lifestyle, you can begin to compare offerings from various lenders. You’ll want a standard FHA home equity conversion mortgage (HECM), not a product from a private lender that might seem more attractive but that doesn’t have federal guarantees that they’ll be around to pay out on your line of credit.
There are differences in the terms HECM lenders may offer.
—Consider the interest rates being charged. Almost every reverse mortgage these days charges an adjustable rate, pegged to an index of Treasury rates. Some lenders charge a higher “margin” over the index, while some charge lower rates but build in higher fees!
—Compare the origination fees. Those fees are capped at $6,000 per mortgage, but many lenders advertise lower or even zero fees to set up your reverse mortgage. (They are building their profit into the interest rate charged.)
—Compare the total amount of equity they calculate you can withdraw from your home.
You must do your homework in this process and not just fall for the glossy brochure in the mail. Start at ReverseMortgage.org, where you can search for an HECM lender in your state and use their online calculator to get a rough idea of how much money you could get in a lump sum or line of credit. They also have a link to HUD-approved independent counselors.
Don’t be deterred by the complexity of the process, or the painful discussions about mortality that underlie this decision. A reverse mortgage can be a helpful solution if done correctly. And that’s The Savage Truth.
(Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” Terry responds to questions on her blog at TerrySavage.com.)