Reverse Mortgages: The Best Way to "Eat Your Home"?
Who says you can't eat your home?
A senior citizen who owns a house outright but doesn't otherwise have two pennies to rub together (or who faces a financial crisis they can't afford) does have an option for accessing the equity in their home without having to sell their house or otherwise uproot themselves unwillingly. The tool in such a scenario is called a Reverse Mortgage.
First, the nuts and bolts of reverse mortgages:
The candidate for reverse mortgages must be at least 62 years old, and must have no other mortgages outstanding on the property. Not all homes qualify either (for example many mobile homes are ineligible). There are many hoops to jump through too; The applicant must go through a Department of Housing and Urban Development (HUD) approved financial counsellor.
Once approved, the amount of the reverse mortgage depends on three factors: prevailing interest rates, the appraised value of the home, and the borrower's age (and sometimes health). The lender needs to ensure that the loan amount won't reasonably exceed the value of the home once interest and other charges are levied.
The money is then granted to the borrower either in a lump sum or monthly payments, or a combination of both. The borrower doesn't have to make any repayments, since the lender will recoup their costs (plus interest of course) when the house is sold or when the owner dies. The remainder of sale proceeds over and above the mortgage amount goes to the owner's beneficiaries, and the program is (ideally) structured such that they never end up owing more than what the house is worth.
In order to continue to qualify for the program even after the money is lent, the home must remain the principal residence of the owner.
The initial cost of a reverse mortgage can be quite high, but is usually rolled into the mortgage amount to prevent the cash outlay (which for somebody applying for a reverse mortgage is usually non-existent). Some lenders charge an insurance premium in the amount of 2% of the loan, another 2% for the origination fee, in addition to the closing costs (which include services such as legal, title searches, and appraisal fees). A $200,000 loan, for example, can cost $8,000 plus closing costs which amount to at least another few thousand. And then interest is charged for the duration of the loan on the full amount.
Interest rates are similar to those for Adjusted Rate Mortgages, and they usually change (for example semi-annually or annually) according to the current rates. Since the term of the mortgage is unknown at the outset, fixed interest rates are not often available.
The money is most often not taxable, and although the interest can be deductible, it is not so until the interest is actually paid (at the end of the term).
- Many seniors when faced with financial trouble don't want to consider the thought of moving from the home they've likely lived in for decades. It is a change often beyond their comprehension, and a sacrifice in their perceived quality of life. A reverse mortgage could allow them to stay in their home.
- If you receive certain social benefits programs (eg: Medicaid), and you opted for a lump sum reverse mortgage amount that then sits in your bank account (or other near-cash investment), then you are all of a sudden considered to have liquid assets and your ability to qualify for the benefits is jeopardized.
- It ain't cheap, when you calculate the fees, closing costs, insurance, and interest.
- Although the program is structured so that the amount borrowed including interest and other costs never exceeds the value of the house, I'm not so sure. If the borrower was initially fairly young (early-mid 60's for example), and the maximum amount was borrowed as a lump sum, I see an opportunity for the perfect storm. All the borrower has to do is live longer than anybody had suspected (each year increasing the interest dollars owed), the interest rates increase dramatically, and the house values in the area drop. However the good news is that the lender (or the insurance the lender purchased) covers any additional costs. It just remains that no additional funds would be available to beneficiaries.
To anybody in a situation where you (or family members) are considering a reverse mortgage, I can only offer this advice: Thoroughly do your research and examine all your options.
Some alternatives to reverse mortgages are:
- Selling the home. You may discover that buying or renting another place and pocketing the extra cash isn't as traumatic as predicted, and in fact could give you a new lease on life! However it may also entail too much outlay of expenses in moving, closing costs, and sales commission.
- Many states offer "no-cost" or "low-cost" reverse mortgages. These often don't carry the same prohibitive fees as the more conventional reverse mortgages, but the interest rates are higher.
- Home Equity Line of Credit (HELOC). There are very few upfront costs, but interest-only payments are required and the rate of interest is a touch higher.
- Get a loan from a family member.
- Consider a sale-leaseback situation, where somebody buys the house, but then allows you to lease it from them. This gives you the cash needed from the sale, and the ability to remain in your home by paying rent.
For those considering moving or relocating to assisted housing, here is a link to help you determine what housing choices are available out there.
Be realistic about what your situation is, and make sure all your ducks are in a row. The reverse mortgage may be just what the doctor ordered. But don't jump to this option before exhausting all other options, as the costs can be high.
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