17 reverse mortgage facts you should know
Baby Boomers are not prepared for retirement. Business Insider does a good job of describing the problem: few seniors have enough savings for retirement, and that’s consistent across generational groups, race, and political affiliation.
However, when looking at data from the 2013 American Housing Survey, one thing is clear – America’s seniors own homes. According to the survey, over 65% of senior homeowners own their house outright. On average, they carry a significant amount of home equity – nearly $130,000.
Is a reverse mortgage a good idea?
Considering these two facts together, I foresee a boom in reverse mortgages on the horizon. A home equity conversion mortgage (HECM), often called a reverse mortgage, allows retirees to cover large expense using home equity, increase their monthly income, or both. Some seniors may not have a choice in the matter.
If the use of reverse mortgages becomes widespread, it’s important to learn a little bit about how they work. This isn’t just the work of seniors. I fall into the millennial demographic and I consider this everyone’s problem.
If reverse mortgages are used responsibly, they can keep our parents and grandparents financially independent and comfortable through retirement. If used improperly, or if the borrowers don’t understand what they are agreeing to, as a nation we could face another housing crisis and the elimination of decades of accumulated wealth.
I’ve covered how these loans actually work in other articles. Below, I’ve created a sort of highlight reel – the 17 important facts you should consider before getting a reverse mortgage.
17 facts about reverse mortgages
#1 – Reverse mortgages can be dangerous
Let’s not skirt around this. These loans can be dangerous. Sure, they solve a major problem faced by many retirees. But when you jump into a reverse mortgage without understanding how the loan works, you can end up up with no home equity. That being said…
#2 – The government has recently made reverse mortgages much safer
The most common reverse mortgage, the Home Equity Conversion Mortgage, is administered by HUD and the FHA. My guess is they see the writing on the wall with the retirement crisis. With a growing market for these loans, they have recently taken action to make HECMs safer for borrowers.Changes to the program have been implemented as recently as last year.
As of April 2015, all reverse mortgage borrowers must pass a financial assessment to qualify for their loan. Prior to this, borrowers qualifications were low – now lenders are required to pull a credit history and assess income streams. Lenders also must set aside money for things like property taxes, homeowners insurance, or required maintenance if the borrower cannot afford them.Another major change to the HECM program has to do with surviving spouses.
Prior to 2014, if the primary borrower on the mortgage died, and their surviving spouse was not included on the loan, the surviving spouse was at risk for eviction. HUD & the FHA recently took action to eliminate this heartbreaking possibility, ensuring that surviving spouses can live in the home and continue to receive the reverse mortgage distributions, regardless of whether or not they are a named borrower on the loan. These safety features help eliminate some of the risk of getting a reverse mortgage, while still maintaining the upside…
#3 – You can receive a one-time lump sum to cover large or unexpected expenses
Reverse mortgage borrowers can receive a lump sum payment at the close of their loan. This is great for retirees that face large or unexpected expenses, like health care treatment. Routine surgeries like a knee replacement can cost $31,124 on average – tapping your home equity may be the best option to pay large bills like this.
#4 – You can receive monthly payments to supplement your income
A major component of the retirement crisis is the lack of stable monthly income. Benefits like social security only get you so far. A reverse mortgage can provide borrowers with monthly distribution payments, using the home equity to bridge the retirement income gap.Depending on the age of the borrower and the value of the home, these distributions can generate hundreds or even thousands of dollars per month to cover expenses.
#5 – Reverse mortgage proceeds are not taxable income
You should take any advice you get on the internet with a grain of salt. We highly recommend you consult your tax professional on this one. But according to the IRS website, loan proceeds from a reverse mortgage are not taxable. Not only can you tap your equity to supplement your income or cover large bills – your money comes tax free.
#6 – Mortgage interest is no longer deductible annually
There’s always a catch right? Yes, your loan proceeds are not taxable income. But if you refinance an existing home loan as part of your reverse mortgage, you will potentially lose a tax deduction.Mortgage interest is only tax deductible when it is paid. In the case of a reverse mortgage, you will not receive the deduction until the home is sold, the debt is refinanced, or some other scenario where the outstanding debt is satisfied.
#7 – You can refinance your existing mortgage
Some seniors carry a small amount of mortgage debt into retirement. This means they’re responsible for monthly principal and interest payments that add up to thousands of dollars a year. With a reverse mortgage, home owners can refinance their existing mortgage debt & eliminate their mortgage payment, freeing up cash to cover monthly expenses.
#8 – You can buy a home with a reverse mortgage
Seniors often downsize their home going into retirement. Once the kids are out of the house, things like a single story home with no stairs become appealing. Many retirees don’t realize you can purchase a home using a reverse mortgage instead of buying all cash. This creates the option to leverage cash for other investments, like dividend paying stocks that generate monthly income.
#9 – Not all housing expenses are eliminated
One of the biggest benefits of a reverse mortgage is the fact that there are no monthly loan payments. However, that doesn’t mean all housing payments are eliminated. The homeowner is still responsible for property taxes, insurance premiums, any HOA dues, and maintenance expenses for the property.
#10 – HECM Loans carry a high cost
Reverse mortgages don’t come cheap. Lender fees for these loans can top $10,000+, not to mention the third party fees for things like a home appraisal. These costs aren’t paid up front, they are usually rolled into the balance of the loan. This helps preserves the borrower’s cash, but it also means the loan costs collect interest over time. Borrowers are encouraged to shop around for the best deal, but any way you slice it part of your home equity evaporates the minute you close your loan.
#11 – There are limits to how much of your equity you can access, and how quickly you can use it
Another safety feature for HECM loans is the “principal limit”. Lenders are only allowed to let you borrow a portion of your home equity, with the rest of the equity reserved to cover interest. This helps make sure the home doesn’t go underwater, which would be bad for both the lender and the homeowner.
Principal limits are calculated based on the age of the youngest borrower and the total value of the home.In addition to limiting the amount of money you can borrow, the FHA also limits how quickly you can withdraw your money. Generally borrowers can only access 60% of their principal limit within the first year of closing their loan.
#12 – Some reverse mortgages have adjustable interest rates
Borrowers that choose to receive monthly payment distributions from their lender don’t have a choice – they are required to have an adjustable interest rate on their loan. Worse, these rates are often tied to short term indexes, like the 1 month LIBOR rate, which tend to be more volatile.As with any adjustable rate loan, there are pros and cons. With US interest rates so low, this isn’t a huge problem. However, if rates continue to go up, the interest rate on your reverse mortgage will go up with it.
#13 – You still benefit from your home appreciation
Just because you have a reverse mortgage doesn’t mean you lose out on things like home appreciation. Regardless of your loan type, when you sell your home there is a priority that dictates who gets paid what. First, the realtors take the commissions. Then the lender is repaid the principal debt & interest. Other liens are paid, like mechanical liens or outstanding HOA dues. The owner pockets the rest. For a reverse mortgage, this is no different!
#14 – You may have less equity to leave to your heirs
Yes, you’ll keep your appreciation. But reverse mortgages are negatively amortizing loans – because you don’t make a loan payment until you sell your home, the principal balance of the debt grows every month. The interest on that debt grows monthly as well.If you live long enough, or interest rates climb rapidly, there is a chance you will outlive your equity. When the home is sold, or the homeowner passes, the entire proceeds after paying realtor fees may go to the lender to satisfy the debt. This means the homeowner or their heirs will walk away with no cash at the close of the sale – but on the bright side, they won’t be responsible for any debt overages either!
#15 – It could affect your government benefits
This is another instance where I recommend consulting a professional. Your reverse mortgage should not effect programs like Medicare or your Social Security benefits. Some financial advisors actually advocate using a reverse mortgage as a tool to delay Social Security benefits, giving you a larger benefit later on.
However, income from your reverse mortgage may affect your eligibility for needs-based government programs, like Medicaid or Supplemental Security Income benefits. If you are receiving support from any needs-based programs, you should consult a professional to make sure a reverse mortgage won’t affect your eligibility.
#16 – Reverse mortgages are increasingly difficult to get
This is a result of regulators adding safety measures of the loan product. There are increasingly strict limitations on who qualifies for a reverse mortgage. As mentioned above, borrowers must pass a financial assessment, which includes the analysis of their credit history.They also have to satisfy an equity requirement to be eligible for the loan. On top of that, the property must meet certain qualifications. To see the full list of eligibility requirements, you can visit the HUD website.
#17 – You may have other options
A reverse mortgage is not your only option to tap your home equity. There are other government backed loan programs, like cash-out refinance loans or home equity line of credit mortgages. Both will allow retirees to liquidate home equity to cover bills or generate monthly income.