You may have seen the television commercials promoting the benefits of reverse mortgages with celebrity spokespersons such as Tom Selleck and Henry Winkler. What is a reverse mortgage and is it right for you? A 2015 report from the Consumer Financial Protection Bureau (CFPB) found that after seeing the advertisements, many consumers were confused about how the product works.
While reverse mortgages can help some older homeowners meet their financial needs, the CFPB report cautions that the loan could jeopardize seniors’ retirement security if not used carefully. Mike Sullivan, personal finance consultant at Take Charge America says there are eight questions seniors need to ask before signing on the dotted line.
What is a reverse mortgage?
A reverse mortgage, also known as a home equity conversion mortgage (HECM), is a home equity loan that allows homeowners 62 and older to convert part of their home equity to tax-free cash. Instead of making payments to a lender like a conventional mortgage, the lender makes payments to the borrower. The loans are available through lenders approved by the Department of Housing and Urban Development (HUD).
What are the fees?
Sullivan says consumers should be aware of the costs associated with a reverse mortgage. He says upfront fees including origination fees and closing costs can be significant.
“There’s the mortgage insurance premium, typically two percent as well as annual payments,” Sullivan says. “There’s a high origination fee and there are monthly service fees. So it’s a very expensive way to borrow money compared to other means.”
What happens to my existing mortgage?
Seniors with an existing mortgage – or any of liens against their home – must pay off the loans with the reverse mortgage. In other words, they cannot have a traditional mortgage and a reverse mortgage at the same time.
“If you already have a mortgage, you have to pay that off before you can take any of the other cash from the HECM,” Sullivan says. “The first part of the reverse mortgage proceeds has to pay off the existing mortgage.”
What about taxes and insurance?
While seniors do not have to make payments against a reverse mortgage, Sullivan says they are still responsible for paying property taxes and homeowners insurance on the home.
“You will still need cash,” he says. “Some of the proceeds from the reverse mortgage have to be kept aside for paying those kinds of expenses or you will still lose the home.”
What about home maintenance?
Once you take the cash from the reverse mortgage, Sullivan says you are still responsible for anything that goes wrong with the house.
“If you have to put a new roof on that house, if you have to replace the water heater or make other kinds of repairs or improvements to the house, you can’t take another loan out against the equity in the home,” he says. “You have to keep enough cash so that you can pay those required maintenance costs.”
Do I have to repay the mortgage?
Given the costs of a reverse mortgage, Sullivan says it may not be a good option for seniors in poor health or someone who intends to move in a few years.
“The home equity comes due when you are away from the house for 12 consecutive months, if you don’t pay some of the things that are due or worse if you die,” he says. “If your days of independent living are numbered and you know you are going to have to live with one of your children, go into assisted living or something like that, your home equity loan is basically due. It is done at that point.”
What about the equity in my home?
A homeowner has full equity in their home once they completely pay off the mortgage. Sullivan cautions that once you take out a reverse mortgage, your home equity is reduced by the amount of the loan. Typically, the funds are repaid when the heirs sell the house. If they elect not to sell, the heirs are responsible for repayment of the loan.
“If you were intending to leave that home to your heirs, children or other people, there’s not going to be anything to leave them,” he says. “We’ve found they [reverse mortgages] are much less popular with the seniors’ children than they are with the seniors.”
Do I have to go to counseling?
Sullivan says to obtain a reverse mortgage, HUD requires seniors to undergo reverse mortgage counseling from an approved third-party organization.
“There is a class that can be done over the phone or in person,” he says. “It usually takes not much more than an hour or two. A certified counselor has to help the seniors understand the loan terms, tax implications and also to discuss alternatives.”
While a reverse mortgage can be extremely valuable for seniors with a real cash need, Sullivan says it’s important for them to consider all of the factors.
“It certainly is better than eating cat food,” he says. “If this is where your assets are and the only way you can get money for medicine, food or other things you need to have, then you should probably consider it. But it’s still a loan and a very expensive loan.”
Linda Bell joined FOX Business Network (FBN) in 2014 as an assignment editor. She is an award-winning writer of business and financial content. You can follow her on Twitter @lindanbell