If you’re a homeowner nearing retirement age, you’ve probably seen the TV commercials about reverse mortgages. Tom Selleck offers a friendly explanation of reverse mortgages and how people use them. How accurate is what he and other proponents of reverse mortgages indicate? Are reverse mortgages actually a good strategy to help fund your retirement?
How Does a Reverse Mortgage Work?
The most common type of reverse mortgage is called a Home Equity Conversion Mortgage (HECM). A HECM is the only reverse mortgage program insured by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development (HUD). HECM loan amounts are based on borrower age, home value, and current interest rates.
HECMs and other reverse mortgage products work similarly to a regular mortgage, with closing costs, interest rates, and mortgage insurance — but instead of making payments, you receive payments from your home’s equity to help supplement your retirement income.
Who Can Get a Reverse Mortgage?
If you’re over 62, own your home, and have significant equity in your home, you may be eligible for a reverse mortgage. Some proprietary reverse mortgage products are available for people as young as 55 in some states. Even if you have an existing traditional mortgage (sometimes called a forward mortgage), where you make a payment each month, if you have significant equity in your home you can obtain a reverse mortgage, and the first thing the reverse mortgage loan amount will be used for is to pay off the existing mortgage so that you no longer have to make monthly mortgage payments, thereby immediately increasing your monthly income by the amount of your paid-off mortgage payment.
When you take out a traditional mortgage loan, you’re borrowing a lump sum from the lender; the lender gives you that lump sum immediately (you typically never personally receive the loan because it goes directly at settlement to purchase your home), and you have to start paying it back, with interest, starting the following month and continuing for the term of a mortgage loan, typically between 15 years and 30 years. At the end of the term, the loan is paid down to $0.
A reverse mortgage works in reverse. Depending on the reverse mortgage program, you can get payments via a line of credit, a lump sum, monthly payments over a set term (sometimes along with a line of credit), or tenure payments for the rest of your life. There are also combinations of these options that get more complicated, but these five main options are explained in more detail below.
Types of Reverse Mortgages
1. Line of credit
Most people who get a reverse mortgage get a reverse mortgage with a line of credit payment plan, which has an adjustable interest rate. This payment plan provides the most potential of growing your retirement income, depending on how you use your credit. In general, you can access up to 60 percent of your principal limit in the first year. In the second year and beyond, you gain access to the remaining 40 percent as well as whatever you didn’t use in the first year. Your available line of credit only decreases if and when you use it, and the interest and mortgage insurance that you have to pay will only be owed for the money that you actually borrow from the line of credit.
2. Fixed-rate lump sum
The fixed-rate lump-sum payment plan is the only type of reverse mortgage that has a fixed interest rate. When you get this type of reverse mortgage, you must take out the entire loan amount all at once, at closing. This option might be the best if you are using most or all of the proceeds from the reverse mortgage to pay off your existing traditional mortgage.
If you’re not using the proceeds to pay off your existing mortgage, then it’s very important that you create a strong financial plan to manage the large sum that you will be receiving all at once.
3. Term reverse mortgage
With a term reverse mortgage payment plan, you get equal monthly payments until you have reached the loan’s principal limit. If you outlive your loan, you can still stay in your home as long as you meet the loan obligations (paying property taxes and homeowner’s insurance, keeping the home in good shape), but you won’t be able to get any more loan proceeds.
4. Modified term reverse mortgage
A modified term reverse mortgage allows you to receive your proceeds as a fixed monthly payment for a certain number of months and allows you to still have a line of credit that you can use to take out additional funds if and when needed.
5. Tenure reverse mortgage
Tenure payment plans provide equal monthly payments until you die, as long as at least one borrower uses the home as their primary residence. This type of payment plan is great if you think you might live a long time, and you are worried that you may run out of money. But the downside, of course, is that the monthly payment will be less than under the prior payment plans.
The interest and fees associated with the reverse mortgage loan get rolled into the balance each month. That means the amount you owe grows over time, so your home equity generally decreases over time (assuming the value of your home stays the same). You get to keep the title to your home the whole time, just as you do with a regular mortgage. The balance of the reverse mortgage isn’t due until one of the following triggering events occurs:
To avoid default, you must keep up with your property taxes as well as your homeowner’s insurance.
When one of the triggering events occurs, the home must be sold, and proceeds from the home’s sale are used to pay off the balance of the reverse mortgage. If there’s any equity left over, it goes to you or to your estate. If you wind up having the reverse mortgage for quite a long time, and the loan balance at the time of the triggering event is more than the value of the home, your heirs are never required to pay the difference; the lender has no recourse against your heirs, which is why a reverse mortgage loan is a “no recourse loan.” Heirs also can choose to pay off the reverse mortgage or refinance if they want to keep the property.
Can Anyone Take Out a Reverse Mortgage Loan?
As mentioned earlier, reverse mortgages are generally available to homeowners who are 62 and older, though some reverse mortgage products are available to people as young as 55 in some states. Aside from age, other reverse mortgage requirements include:
Is a Reverse Mortgage the Best Option for You?
Reverse Mortgage loans can sound pretty appealing, especially if most of your net worth is tied up in your home. However, there are pros and cons to all financial decisions. Surprising to some, AARP research indicates that reverse mortgage borrowers are almost always happy that they obtained a reverse mortgage. Findings are as follows:
But there are some definite downsides, too. If you’ve been considering this type of loan, first make sure to weigh all the pros and cons of a reverse mortgage before you sign on the dotted line.
Reverse Mortgage Pros and Cons — Do the Advantages Outweigh the Disadvantages?
Advantages of a Reverse Mortgage
The main advantage of reverse mortgages is that you can eliminate your traditional mortgage payments and/or access your home equity while still owning and living in your home for the rest of your life. Given the right set of circumstances, a reverse mortgage can be an ideal way to increase your spending power and financial security in retirement. If you want to age in place and need in-home care in order to remain at home, and if you have run out of financial assets and don’t have enough monthly income to pay for the required in-home care, a reverse mortgage is often the only way to stay in your home.
Advantages of reverse mortgages include:
Disadvantages of Reverse Mortgages
So, what is the downside of a reverse mortgage? Though there are many benefits, there are also some downsides to consider.
Should You Get a Reverse Mortgage?
A reverse mortgage is helpful for many people and essential for people who want to live at home with in-home care and have no other means to pay for that care. But a reverse mortgage of course is not a good idea for everyone. Ultimately, the decision to take out a reverse mortgage is one you should weigh carefully with the help of your Elder Law attorney and financial advisor. Though it’s an easy way to get cash, it could put your finances at more risk in the long run and could eventually leave your heirs with a lot less if that matters to you.
Reverse Mortgages Do Not Affect Medicaid Eligibility
As mentioned above, please keep in mind that if you should need nursing home level care in the future (either at home or in a nursing home), a reverse mortgage does not affect Medicaid eligibility. Keeping money in a reverse mortgage line of credit does NOT count as a resource for Medicaid eligibility purposes, so long as the house itself is an exempt resource, which it is so long as you’re living in it; and in some states, the home is also temporarily exempt if you go into a nursing home. However, transferring money from a reverse mortgage line of credit to a bank account and leaving it there past the end of the month would generally convert the exempt home equity into a countable resource and that could make you lose your Medicaid eligibility. For more details on the advantages and disadvantages of reverse mortgages, please read our articles on the subject here.
Planning for Long-Term Care
If you or your loved one is facing the possible need for long-term care and/or thinking about getting a reverse mortgage, you should get an opinion from an experienced Elder Law attorney who is also experienced with reverse mortgages, such as myself, before moving forward. Please call us to make an appointment:
Fairfax Elder Law: 703-691-1888
Fredericksburg Elder Law: 540-479-1435
Rockville Elder Law: 301-519-8041
DC Elder Law: 202-587-2797
About Evan H Farr, CELA, CAP
