There are certain real estate topics that seem to generate a fair amount of excitement and interest among our readers. One of those is a reverse mortgage.
A reverse mortgage allows homeowners aged 62 and older to convert their home equity into either a single lump sum or regular payments, which can be used to fix up the property or travel or even as a supplement to Social Security or other retirement income. Sometimes, a reverse mortgage is used to eliminate a traditional mortgage and free up cash flow for the homeowner.
Unlike a traditional mortgage, where you make regular monthly payments to pay off the loan over a specific period of time, a reverse mortgage requires no monthly payments. The amount due rises over time, and is paid off in full when the home is sold or the owner no longer lives there full-time.
Our recent article on reverse mortgages certainly got the attention of our readers. We’d like to share some of their comments (which have been edited for clarity and length):
Comment: I almost got a reverse mortgage with my wife a few years ago. The thing that stopped us was I had a low credit score and the amount of money we’d have access to in the line of credit was pitiful. It was also expensive: The only way there would be any house value left for heirs after 15 years would be if the real estate market was on fire. We could literally find no one, out of five financially knowledgeable people we spoke with, that would speak positively about reverse mortgages. In some circles, those who get reverse mortgages are considered “poor.”
I think financial advisors who work with clients nearing retirement should strongly encourage them to get a “cash out refinance” before they stop working (and lose the income). This would avoid the pressure to take out a reverse mortgage and leave their clients in a stronger financial position. This is what we ultimately did.
This is a far out idea (for a lot of reasons), but in comparison with getting a reverse mortgage, it may be better to take a job long enough to qualify for “cash out refinance” (if your health allows it).
Comment: I looked into a reverse mortgage that I saw advertised on television. I received the CD disk from that company by mail.
The CD disk was all advertising, with no specifics or details about reverse mortgages, and nothing about financials, dollar loan amounts and costs. I had to call them to get the details. On the telephone, I told them that I wanted a reverse mortgage on my house, which was valued at about $200,000.
I also informed them that I am 68 years old, that my FICO credit score is 810, and I fully own the house with no outstanding mortgage. They told me that the maximum loan they give is 50% of the value of my house, or around $100,000. They also let me know that the cost to get the loan would be about $15,000. Therefore, the net amount I would receive from a $100,000 Reverse Mortgage was $85,000.
With the higher interest rate and the huge upfront fee, I found the reverse mortgage from them to be utterly ridiculous!
Our take: Well, these two readers haven’t had a good experience with reverse mortgages. As we’ve said before, reverse mortgages aren’t for everybody. Indeed, they may only be an option for those who need cash now for some purpose.
There are three types of reverse mortgages: single purpose, proprietary and Home Equity Conversion Mortgages (HECM).
- Single purpose reverse mortgages, which are offered by government agencies and nonprofits in some areas, are the least expensive option but use of funds is restricted.
- Private companies offer proprietary reverse mortgages, which seem to be the options explored by our readers. These are typically more expensive, and the amount you receive is based on a complicated formula that evaluates a variety of factors, including your current home equity and your age (and that of your spouse).
- HECM reverse mortgages are federally insured, backed by the Department of Housing and Urban Development, and which place no limits on what you can do with the funds.
As our reader with the $200,000 home noted, senior homeowners who are still employed might be far better off trying to do a cash-out refinance or even take out a home equity loan or line of credit before they stop working. On a $100,000 loan from a conventional lender, that reader might spend between $2,000 and $3,000 in closing costs on a cash-out refinance. And, in some situations, the lender might provide for a slightly higher interest rate but lower the closing costs to zero. In the end, if the homeowner qualifies for a $100,000 cash out refinance, that homeowner would end up with $100,000 in the bank, having paid no closing costs.
However, with a conventional mortgage, the homeowner will have to make monthly mortgage payments of principal and interest to the lender for the term of the loan. A reverse mortgage only requires homeowners to pay their real estate property taxes. So, if cash flow is everything, a traditional mortgage may be difficult.
For many older homeowners, their home is their single largest part of their net worth. Leaving an inheritance is an important goal, and often their home is the only asset they can leave to their kids. Getting a reverse mortgage will eat up a substantial portion of home equity, perhaps even all of it depending on how long the owners live after taking out the reverse mortgage.
As our second reader mentioned, he’d end up with $85,000 in cash up front and never have to repay it. But, if he lives long enough, it’s likely that his family would get nothing as the loan would eat up the equity in the home and the reverse mortgage company would sell the home to pay off the debt owed to them.
These are incredibly difficult, expensive decisions to make. And while reverse mortgage commercials are fronted by actors who are familiar, friendly, and perhaps even reassuring, take your time to fully think through the issues associated with a reverse mortgage before you sign on the dotted line.
(Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (4th Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact Ilyce and Sam through their website, bestmoneymoves.com.)