Due to the escalating costs of healthcare, living expenditures, and Social Security constraints, many Americans reach the age of 62 without sufficient retirement savings. A reverse mortgage may help you meet your bills, but is it wise to dip into your home’s equity?
Follow along as we define and explain the operation of reverse mortgages.
What Is a Reverse Mortgage?
A reverse mortgage is a tax-free loan that allows you to borrow against your home’s equity. In contrast to a conventional mortgage, in which you make monthly payments to pay down your debt, you get payments from the lender with a reverse mortgage loan. While you are no longer required to make monthly mortgage payments, you are still liable for property taxes, homeowners insurance, and house maintenance.
A reverse mortgage has only a few primary requirements:
- You must be 62 years or older.
- You are only permitted to obtain a reverse mortgage on your principal house.
- The Department of Housing and Urban Development requires you to attend a reverse mortgage counseling session if you get a home equity conversion mortgage (HECM) (HUD).
Once you’ve applied, your loan type will dictate how you may spend the money. In most circumstances, you will be allowed to spend the money you like. In general, reverse mortgages are designed for retirees who wish to reduce or eliminate their monthly mortgage payments to manage their monthly costs better.
How Do Reverse Mortgages Work?
Obtaining cash from your mortgage may sound too wonderful to be true. Ultimately, where will the money come from if you still need to pay off your mortgage and aren’t selling your home? It is derived from the equity in your property.
It is crucial to note that a reverse mortgage is still a loan and that the money you get is your own money secured by your house.
Your reverse mortgage lender will request an appraisal of your house to calculate the loan proceeds. Then, they will utilize the money to pay off your current mortgage. The remaining money is yours to use as you like, including covering your living expenses, paying off debt, building an emergency fund, or purchasing a property. You are eligible for the entire loan amount if you own your house free and clear.
Accounting for Taxes, Interest, Insurance, and Fees
It is essential to realize that a reverse mortgage does not provide free money. “Reverse” refers to the balance of your loan. While you remain the owner of your house and continue to receive payments, monthly interest is added to the loan total, increasing your debt throughout the life of the loan if you do not make payments.
Even if you do not make payments, you will be unable to delay all your mortgage obligations. You will still be responsible for paying the following:
- Real estate taxes
- Property insurance
- Arrangement costs
- Closing expenses
- Home maintenance
If you get behind on property taxes or insurance or allow your home to deteriorate, you might lose your home to foreclosure.
How Does One Repay a Reverse Mortgage?
As previously stated, you can make monthly loan payments, but repayment is only needed once you sell the property, move out, or die. When you sell your house, the proceeds will repay your current reverse mortgage plus accrued interest.
This implies you will make less money on the sale than on a conventional mortgage. Reverse mortgages allow you to take benefit of your home’s equity sooner rather than later, which is why these loans are designed for senior homeowners.
Your loan is deemed non-recourse if you have a government-backed HECM, meaning you will only owe what your house is worth. The difference will not be due if you sell your home for less than what you owe.
If you die away and your heirs choose to keep the property, they can refinance to a standard mortgage or acquire it for the amount owing on the reverse mortgage or 95% of the home’s assessed value, whichever is less. They can also sell the property and keep the proceeds once the debt has been repaid, or they can hand over the deed to the lender.
Typically, the option your heirs choose will rely on the house’s equity. If passing your property to your heirs, with or without a typical mortgage, is a top priority, you should avoid this type of financing.
Types of Reverse Mortgages
There are three primary reverse mortgage kinds.
Home Equity Conversion Mortgage (HECM)
The most prevalent variety is the HECM reverse mortgage, secured via FHA-approved lenders. You can use the funds from a HECM loan for any purpose. These are guaranteed by the U.S. Department of Housing and Urban Development (HUD) for up to $9,708,000 in 2022. If the value of your house exceeds $970800, you may consider a proprietary loan, commonly known as a jumbo reverse mortgage.
Single-Purpose Reverse Mortgage
The least costly option is a single-purpose loan, which varies from standard HECM loans because it can only be used for a single, lender-approved purpose. For instance, the lender may stipulate that the loan can only be used for house improvements, property taxes, or insurance payments. These loans originate from local governments and philanthropic groups and are intended for low- and moderate-income homes, but they are not accessible everywhere.
Proprietary Reverse Mortgage
A reverse mortgage offered by a private lender is proprietary. If you own a house with a high value, you may require this form of loan to borrow more dollars. Keep in mind that the federal government does not guarantee a private reverse mortgage and, thus, does not offer the same safeguards to borrowers.
Selling Your Residence With a Reverse Mortgage
You may still sell your house even if you have a reverse mortgage. However, you are required to repay your loan after selling your house. Before you put your house for sale, clarify the amount you owe to your lender. If your home sells for more than its appraised worth, you may keep the difference and apply it toward a new home.
If your property sells for less than what is left on the mortgage, you will not be liable for the difference. As long as your loan is non-recourse, you will never pay more than the value of your property.
The Positives and Negatives of Reverse Mortgages
As with any significant financial decision, examining the benefits and disadvantages is essential to ensure that this is the best choice. Here are some examples to get you started.
Advantages of Reverse Mortgage
- You are permitted to remain in your house, and your name remains on the deed.
- You may access the equity in your property without selling it or paying monthly mortgage payments.
- As non-recourse loans, reverse mortgages are not affected by a decline in house prices.
- Even though they are not the borrower, your spouse may be permitted to continue living in your house following your passing.
Disadvantages of Reverse Mortgages
Only some qualify for these loans. Before you purchase one, you might want to consider the following disadvantages:
- Reverse mortgages reduce the amount of home equity you have.
- Your loan debt will grow if you do not pay your interest over time.
- You must select to receive monthly payments during the term of your loan to avoid outliving its advantages.
- A reverse mortgage might make it more challenging for your heirs to profit from your home’s wealth after your death.
As with all loans, you should also be aware of several reverse mortgage frauds. Verify your loan, and be wary of contractors that advise loans to pay for house repairs or veteran-specific programs. The Veterans Administration (VA) does not support reverse mortgage loans.
Reverse Mortgage vs. Refinance: Which Is Better?
Reverse mortgages are a viable option for seniors who need more retirement income but wish to remain in their houses. However, there may be better options than this if you intend to leave your house to your children or if you intend to leave the property shortly.
There are alternative refinancing choices for seniors if you are still determining if a reverse mortgage is correct. For a homeowner in the appropriate circumstances, one of these mortgages might be a feasible or even superior alternative, as it meets one of the primary aims of a reverse mortgage – accessing equity – while allowing you and your heirs greater freedom.
Rocket Mortgage provides cash-out refinancing options. Consult our refinancing guide to determine if this option makes sense for you.
Conclusion: Is a Reverse Mortgage a Good Idea?
When determining whether to obtain a reverse mortgage, keep in mind that the primary benefit of this loan is that it enables you to spend your funds immediately, but you will have less money saved in the future. Think about your present financial condition and where you hope to go in a few years. If you have already closed on a loan, keep in mind that you have three days to exercise your right of rescission.