Reverse mortgages have gained a bad reputation over the years, but they can be a good financial move for a certain segment of the market, experts say.
“They do make sense for people who have no other alternatives,” says Susan Tiffany, director, consumer periodicals at the Credit Union National Association. “What happens over time is people build equity in their home and until recent years, the equity was illiquid. They couldn’t tap it without selling the house or getting a home equity loan. A reverse mortgage lets you get at that equity.”
Whether you are looking to pad your nest egg or need the cash flow, before you move ahead with this type of mortgage product experts say there are a few things you need to take into account.
Your Age Matters
To be eligible for a reverse mortgage, homeowners have to be age 62 or older. A home has to have equity so there’s money to drawn down. For example, if a home is worth $250,000, a reverse mortgage allows up to that amount as either a line of credit, a lump payment or monthly installment payments.
“The way the programs are constructed the amount of money you get is based on the home value and the age of the youngest borrower,” says Gerald Wagner, president of Ibis Software, which specializes in reverse mortgage analysis. “The older you are, the more you get.”
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Can You Afford the Maintenance, Taxes and Insurance?
A reverse mortgage provides access to the equity in a home, but isn’t free money.
In addition to the fees associated with taking out this type of loan, the homeowners are still on tap for the property taxes, insurance and maintenance of the home.
“If you don’t take care of those things, the mortgage can come due,” says Tiffany. Keep in mind that the interest on a reverse mortgage can’t be written off on a tax return until the loan is paid off partly or in full, she adds.
Taking Out a Reverse Mortgage Isn’t Free
Just like with a traditional mortgage, there are costs associated with a reverse mortgage. According to the Federal Trade Commission, lenders typically charge an origination fee, a mortgage insurance premium and other closing costs.
Wagner points out that the mortgage insurance portion has been cut down to half a percent in the last few years. “A lot of the fear on reverse mortgages is the fees are so expensive. “Lenders will do loans with almost no loan fee.”
In addition to fees, the FTC says borrowers have to keep in mind that the amount they owe will increase over time since the interest is charged on the outstanding balance and added to the amount that’s owed.
It’s also important to point out that most reverse mortgages have variable rates that are tied to a financial index, which means the rate will likely change based on market conditions.
Discipline is the Name of the Game
Stories of seniors who took out a reverse mortgage, blew all the money in a year or two and ended up in a worse financial situation then when they started, are commonly associated with reverse mortgages, and gives them a tarnished rap,
While Wagner says taking out a reverse mortgage is a great way to take advantage of low rates and access the equity in a home, he cautions to only make the move if the money is used smartly and not wasted on unnecessary things.
“This is a stand by line of credit,” says Wagner. “If rates go back where they were on average in the last 10 years, the amount of money you get is one-third if you wait and do it another time.”
Your Heirs will Have to Buy the Property After Your Death
Many people want to be able to pass down their home to their heir, and that’s not always an option under a reverse mortgage.
If a home has this type of mortgage, the survivors have to purchase the home. Even though most reverse mortgages have a nonrecourse clause which prevents anyone from owing more than the value of the home when the loan comes due, if heirs want to retain ownership, they typically have to repay the loan in full, according to the FTC.
“A reverse mortgage might not be the only option,” says Tiffany. “You may be trying to solve a shorter term need with a longer term solution.”