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For senior homeowners needing some extra cash, it’s sometimes better to look backwards instead of forwards – with their mortgage, that is.
Reverse mortgages are not easily understood, and many who could benefit from them shy away, afraid of making a mistake. Journalists who have only a cursory understanding of the product may contribute to this. This post lays out the pros and cons of reverse mortgages, and when you’re finished reading, you should be able to confidently determine if they are right for you or someone you care about.
What exactly is a reverse mortgage?
A reverse mortgage is exactly what it sounds like. With a forward (i.e., regular) mortgage, you start with a principal balance and make payments until the loan is paid off and you own your home outright. With a reverse mortgage, the lender makes payments to you. Repayment on a reverse mortgage is not required until the home is no longer your primary residence. Because you don’t make payments, lenders don’t care about your credit score or your income when you apply for a reverse mortgage.
Types of reverse mortgages
The most common reverse mortgage is the Home Equity Conversion Mortgage, or HECM. The program is administered by HUD, and its fees are regulated. HUD requires seniors to attend sessions with HUD-approved reverse mortgage counselors before they can take out one of these loans. About 90 percent of reverse mortgages are HECMs.
For very low income seniors, Single Purpose reverse mortgages are a low- to no-cost option that can provide funds for home maintenance or property taxes. They are available from local governments and charitable groups.
Proprietary reverse mortgages are funded by private lenders, and these companies make their own rules. You may be able to borrow a lot more money with these loans, but costs are much less regulated. Counseling is not required, but it’s probably a good idea – see below for more details.
How much can you borrow?
The more equity in your home, the more you can borrow. However, this amount also depends on your age (older people can borrow more), your home equity (if you have a mortgage, it must be small enough that the reverse mortgage can pay it off), interest rates and, for Home Equity Conversion Mortgages (HECMs), HUD’s loan limits.
How should you take your proceeds?
You can customize the way you receive your proceeds, depending on your use for the money. Your reverse mortgage counselor can help you with this.
- Lump sum payment: This is ideal for thing like paying for catastrophic medical expenses or consolidating debt. An unspent lump sum, however, can jeopardize your eligibility for government benefits tied to assets, like SSI and Medicaid. Reverse mortgage proceeds are not countable as income because they are loans. However, Medicaid and SSI eligibility requires applicants to have no more than $2,000 ($3,000 for a couple) in countable assets each day out of the month. So if you took a lump sum distribution and parked it in something like a high interest savings account, even just for a day or two, you’d be ineligible for these benefits.
- Monthly payments: Modified tenure gets you payments for a specified period of time, for example, five or ten years. Traditional tenure gets you payments for life. Although your payments will be considerably smaller, this is a good option for ongoing supplemental income.
- Line of credit: This lets you tap your home’s equity only when you need to. It can be the best choice, like credit cards which charge no interest until you use them.
Combinations of the above options are also available, allowing you to customize your distribution; for example, a lump sum to pay off debt and a line of credit for emergencies.
How much does a reverse mortgage cost?
Like all financing, reverse mortgages come with costs. There is mortgage insurance, which is paid upfront and costs one-hundredth of 1 percent (0.0001) of the property value for HECM Saver (which has lower borrowing limits) or 2 percent for HECM Standard. On a $300,000 home, that’s $30 for the Saver and $6,000 for the Standard. Then there are other charges and of course interest. Lenders have to give you a disclosure called the Total Annual Loan Cost (TALC) which lets you compare reverse mortgage costs.
Because the upfront costs can be substantial, reverse mortgages may not be appropriate for those who can qualify for less-costly home equity loans instead. You should also think twice if you are in poor health or are contemplating a move within the next few years.
Don’t skip counseling
If you have decided a reverse mortgage is your best bet, talk to a reverse mortgage counselor so that you can be an informed shopper. Along with local HUD-approved counseling agencies, there are a number of national counseling agencies that can assist you. While HECM loans are regulated, proprietary loans are not, and even HECM lenders do price differently. Whether counseling is required or not, it’s smart to compare reverse loans and be fully informed before committing to a product.
About the Author:
Lisa White is a writer, editor and marketing professional with more than 25 years of experience. She has worked for a number of corporations, business and consumer publications and associations in a variety of industries, including food/foodservice, retail, distribution, venues/entertainment, finance, health care and insurance. White’s background includes serving as editor for four magazines and assisting in the start up of three publications. She has been an independent writer since 2001 and is based out of the Chicago area.
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