Traditionally considered a last-ditch source of cash for eligible homeowners, reverse mortgages are becoming more popular.
Older Americans, particularly retiring baby boomers, have increasingly drawn on this financial tool to fund things like home renovations, consolidate debt, pay off medical expenses, or simply improve their lifestyles.
So what is a reverse mortgage? It’s a type of loan that allows homeowners to turn part of the value of their home into cash. Available to people 62 or older, a reverse mortgage can be set up and paid out as a lump sum, a monthly stipend, or a line of credit.
Unlike a second mortgage or a home equity loan, the reverse mortgage loan doesn’t have to be repaid until a borrower dies, sells the house, or moves out permanently.
The Federal Housing Authority (FHA) offers a Mortgagee Optional Election assignment program that is designed to allow non-borrowing spouses to stay in the home as long as the loan was taken out after they were married and have stayed married and property taxes are up to date.
Home equity conversion mortgages (HECMs) can also be used later in life to help fund long-term care. However, if the borrower moves to another home for a major portion of the year or to a nursing home or similar type of assisted living for more than 12 consecutive months, the reverse mortgage loan will need to be paid back.
Taking out a reverse mortgage can work for older members of the workforce who need to draw on their home equity to supplement their income as they move into retirement.
But reverse mortgages also come with drawbacks, and they aren’t for everyone. Depending on things like your age, home equity and goals, alternatives like personal loans, cash-out refinancing or home equity loan, may be a better fit and come without the restrictions of a reverse mortgage.
Reverse Mortgages 101
Reverse mortgages were created to help retirees who own and live in their homes but have limited cash flow to cover living expenses. To qualify for a reverse mortgage, all owners of the home must be at least 62 years of age.
Reverse mortgages are only available to people who have paid off their home loan entirely or have a sufficient amount of equity.
Borrowers must also use the home as their primary residence or, if living in a two-to-four unit home owned by the borrower, then he or she must occupy one of the units. Other options that are part of the program are HUD-approved condominiums or manufactured homes that meet the requirements of FHA.
The borrower cannot have any delinquent federal debt. Plus, the following will be verified before approval:
• Borrower income, assets, monthly living expenses, and credit history
• On-time payment of real estate taxes, plus hazard and flood insurance premiums, as applicable
The reverse mortgage amount you qualify for is determined based on the lesser of the appraised value or the HECM FHA mortgage loan limit (for purchase the sales price), the age of the youngest borrower or age of eligible non-borrowing spouse, and current interest rates.
Generally, the older you are and the more your home is worth, the higher your reverse mortgage amount could be, depending upon other eligibility criteria. Borrowers, or their heirs, usually repay the reverse mortgage by eventually selling the house.
The most common type of reverse mortgage is a HECM, which is insured by the FHA and offers certain consumer protections. These loans currently have a limit of $765,600.
One eligibility requirement is that you meet with an HECM counselor. To find one, you can search for a counselor on the U.S. Department of Housing and Urban Development (HUD) site.
The HECM counselor may talk to you about the eligibility requirements of the program, as well as the financial ramifications if you decide to go forward with a reverse mortgage.
The counselor might also discuss how and when the loan would need paid back, including circumstances under which the outstanding amount would become immediately due and payable.
The counselor can also share alternatives to getting a reverse mortgage. The goal is that, through this meeting, you will be able to make an informed decision about whether a reverse mortgage is right for your situation.
Currently, about 40% of older adults who meet with a HECM counselor decide to go forward with the process.
If you’re interested in taking out a reverse mortgage, one place you might want to apply through is a member of the National Reverse Mortgage Lenders Association to help avoid scams. You could also ask your HECM counselor for a recommendation.
As far as costs associated with getting a reverse mortgage, many of them could be paid out of the loan proceeds, meaning that you wouldn’t have to pay them out of pocket. However, financing loan costs reduces how much money will be available for your needs.
Fees involved include but may not be limited to:
• Mortgage insurance premiums:
Upfront fee: 2% of the home’s appraised value iof FHA lending limit (whichever is less)
Annual fee: 0.5% of the outstanding loan balance
• Origination fee
• Third-party charges
• Service fees
Your lender can let you know which of these are mandatory for you.
In addition, you can finance the mortgage insurance premiums. A lender could charge an origination fee as follows: the greater of $2,500 or 2% of the first $200,000 of the home value, plus 1% of the amount over $200,000. The origination fee cap is $6,000.
A lender or agent services the loan and verifies that real estate taxes and hazard insurance premiums are kept current, sends you account statements, and disburses loan proceeds to you.
In return for those activities, they could charge you a monthly service fee. The monthly service fee cannot exceed $30 if the loan interest is fixed or adjusts annually. If the interest rate can adjust monthly, the maximum monthly service fee is $35.
Third-party fees that might exist when applying for the loan include an appraisal, surveys, inspections, title search, title insurance, recording fees, credit checks, and so forth.
Pros and Cons of Reverse Mortgages
If you’re nearing retirement, it’s easy to see why reverse mortgages are appealing. For one, unlike most loans, you don’t have to make any monthly payments. The loan can be used for anything, whether that’s debt, healthcare, daily expenses, or buying a vacation home.
How you get the money is also flexible: You can choose whether to get a lump sum, monthly disbursement, line of credit, or some combination of the three.
You can start paying back the loan whenever you want, even if that means waiting until you’re ready to sell the house. If the home is sold for less than the amount owed on the mortgage, Borrowers may not have to pay back more than 95% of the home’s appraised value because the mortgage insurance paid on the loan covers the remainder.
You can also use a reverse mortgage to purchase a primary residence if you have sufficient funds for the down payment (you essentially need to pay about half of the home’s price using your own cash and savings), as well as the ability to pay for other home costs, such as property taxes and insurance.
If you don’t pay insurance or taxes, or if you let your home go into disrepair, you risk defaulting on the reverse mortgage, which means the outstanding balance could be called as immediately “due and payable”. If you move out of your home, the loan can also become due.
Reverse mortgage interest rates can be fairly high compared to traditional mortgages. The added cost of mortgage insurance does apply, and like most mortgage loans, there are origination and third-party fees you will be responsible for paying as described above.
Finally, depending on market conditions, taking out a reverse mortgage generally means reducing the equity left in your home, which could mean leaving less for those who would inherit your house.
If you decide to take out a reverse mortgage, you might want to talk to a tax advisor. In general, these proceeds are not considered taxable income, but it might make sense to find out what’s true for your specific situation.
A reverse mortgage will not have an impact on any regular social security or medicare benefits. Supplemental benefits could be affected if loan proceeds are retained as assets.
Alternatives to Reverse Mortgages
Depending on your financial needs and goals, a reverse mortgage might not be the best option for you. There are other ways to tap into cash that could offer lower fees and don’t have the same rigid requirements in terms of age, home value, and share of mortgage repaid such as a home equity line of credit or other loan alternatives.
If you can qualify based on your credit and income and don’t need a monthly cash flow to support your basic needs, a personal loan could get you a lump sum of money without diminishing the equity in your home. A personal loan might be a good option if you need to pay off high-interest debt, fund home renovations, or make a big-ticket purchase.
SoFi offers personal loans ranging from $5,000 to $100,000, and unlike with a reverse mortgage, there are no origination fees or other hidden costs.
If you aren’t sure how much your home renovation is going to cost, you could use this Home Improvement Cost Calculator to get an idea.
SoFi makes it easy to apply for an unsecured personal loan with a simple online application and live customer support seven days a week.
Another option is a cash-out refinance, which involves taking out a loan with new terms to refinance your mortgage for more than you owe and pocketing the difference in cash. This type of loan involves credit and income qualifying and is a common way to pay for home improvements or even educational expenses.
Cash-out refinances might be a good option if the new loan terms are favorable and you have sufficient equity in your home. If you don’t have or don’t want to pull additional equity out of your home, you could consider an unsecured personal loan from SoFi.
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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