What Is a Reverse Mortgage? The Real Risks and Rewards, Revealed
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Most home buyers know what a mortgage is, but what is a reverse mortgage? You’ve heard this term bandied about, and maybe have even seen the late-night TV ads promoting them. But people are often confused or all-out clueless on the details, so allow us to explain.
True to its name, a reverse mortgage is the opposite of a traditional loan, where you borrow a couple hundred thousand dollars from a lender and then slowly pay it back month by month—plus interest. In a reverse mortgage, your lender pays you, slowly turning the equity you’ve earned in your home back into cold, hard cash.
However, just because you qualify doesn’t mean this loan option is a good idea for you. Read on to make sure you understand the risks and benefits.
Who can get a reverse mortgage, and what are the benefits?
Reverse mortgages are available to homeowners 62 and older, and can be useful for seniors who may not have much in terms of income or assets. A reverse mortgage easily increases the amount of money they have coming in to cover various living expenses.
“Ideal candidates are those who want to stay in their home, owe little to nothing on it, and need more cash,” says Debbie Worley, president and loan officer at Lone Star Reverse Mortgage in Horseshoe Bay, TX.
The loan must be repaid when the last borrower, co-borrower, or eligible spouse sells the home, moves, or dies.
How much money can I get?
The amount you can qualify for is known as the initial principal limit. The IPL is determined by combining a home’s value, the homeowner’s age, the type of loan, and the interest rate. It’s rarely more than about 60% of the home’s value—and it tops out at $625,500.
There are a variety of ways you can receive money from a reverse mortgage. The standard disbursement options include the following:
Lump sum: You get a large chunk of money (though you can’t access all your equity at once).
Term: The borrower receives monthly payments for a fixed amount of time.
Tenure: The borrower receives monthly payments guaranteed to last until she dies or moves.
Line of credit: The loan amount can be accessed whenever the borrower needs money. And the sum grows in value, not due to interest but the assumption that the home appreciates with time.
Modified tenure/term: A combination of access to a line of credit and term or tenure monthly payments.
When do reverse mortgages need to be paid back?
A reverse mortgage can become due if the borrower fails to pay real estate taxes or homeowners insurance. But what’s more likely is that the borrower moves out or dies—that’s when a reverse mortgage’s outstanding balance needs to be paid off, says Warren A. Ward at WWA Planning & Investments.
In the case of death, the remaining equity goes into the estate. The heirs can still inherit the home as long as the loan is in good standing; in fact, if the heirs make the home their primary residence and meet the loan terms, the reverse mortgage can continue in their name.
The risks of reverse mortgages
In spite of these advantages, reverse mortgages have a bit of a sketchy reputation, largely due to misleading claims made by unscrupulous lenders. In the past, if only one member of a married couple put his or her name on the reverse mortgage—and that spouse died—the surviving spouse could face foreclosure.
Luckily, new laws and safety measures mandate that the surviving spouse cannot be kicked out.
But even though regulations and safety measures surrounding reverse mortgages have improved, these loans still have some sizable drawbacks. For one, they tend to have worse terms than other means of tapping your property’s value, like home equity lines of credit. Plus, the fees associated with a reverse mortgage can rip through a homeowner’s equity quickly.
For instance, an origination fee on a reverse mortgage can amount to a whopping 2% of the initial $200,000 of the home’s value, and 1% of the remaining value, with a cap of $6,000.
Also, keep this simple fact in mind: You’re basically borrowing money from yourself. Meanwhile, your lender is slowly nibbling away at the equity you’ve earned in your home. If you dream of leaving your home to your kids, you should think long and hard before you move forward with a reverse mortgage.
So even if turning your home into an ATM sounds tempting, think through various life scenarios before committing to a reverse mortgage. Shop around to get the right loan product, and check to see if a lender has had any complaints from past borrowers.
Because reverse mortgages can be complex, housing counseling is a must. The National Council on Aging offers counseling through its Reverse Mortgage Counseling Services Network, one of nine national counseling groups approved by the U.S. Department of Housing and Urban Development. There is an upfront fee of $135 for this service (which can be deferred depending on your budget).
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