If you’re at least 62 years of age and you need to access extra funds to cover medical fees, retirement accommodation or daily living expenses, a reverse mortgage may help.
As a government-insured home loan product, a reverse mortgage allows senior citizens to convert the existing equity in their home into liquid cash that can be used for several purposes. Referred to as a Home Equity Conversion Mortgage (HECM), a reverse mortgage can give you the financial liberty you need to make the most of your retirement, whatever your plans may be.
While a reverse mortgage offers several advantages to borrowers, such as the ability to borrow against equity while still maintaining ownership of your asset, be mindful of the costs and risks involved.
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What is a reverse mortgage?
A reverse mortgage allows borrowers to borrow funds against the equity in their home. With a reverse mortgage, payment of the mortgage is not required until the borrower decides to sell the home or passes away. The mortgage is structured so that the loan amount will not exceed the value of the property over the loan term.
A major benefit of a reverse mortgage is that it provides borrowers with cash to fund their retirement without having to make payments like you do with traditional mortgages. Instead, the lender makes payments to the borrower through a lump sum, monthly payments, or a line of credit.
Reverse mortgages also provide borrowers with flexibility to qualify as they don’t have to undergo a credit check.
How does a reverse mortgage work?
A reverse mortgage allows homeowners aged 62 and over to convert part of the equity in their property into cash without having to give up ownership or take on monthly mortgage payments. This loan type is referred to as a reverse mortgage because the lender makes payments to the borrower instead of the borrower making monthly payments to the lender. It’s almost as if the roles are switched.
The loan is then repaid when you decide to sell the property, whereby the remaining equity is transferred to you, or when you pass away.
Pros and cons of a reverse mortgage
- Asset security. With a reverse mortgage, you don’t have to give up title to your home during the loan period, which means you retain full ownership of the property.
- No monthly payments. Given that you occupy the home as your primary place of residence, continue maintenance on your property, and remain current on property taxes and insurance, you don’t have to make monthly payments to the lender. Although the loan is not due until you move out of the property, it can be paid off at any time without incurring prepayment penalty.
- Access to funds. By borrowing against the equity in your home, you can convert a portion of your equity into cash, which can help fund your retirement plans and free up your cash flow.
- No restriction on use of funds. For HECMs and private sector reverse mortgages, you can use the proceeds of the reverse mortgage however you like. Whether it’s to help fund your grandchild’s education, to go on a vacation, pay for medical expenses, or retirement accommodation, the choice is yours.
- High costs. Reverse mortgages are typically more expensive than standard mortgage types due to the high upfront and ongoing costs such as the origination fee, mortgage insurance fees, and title insurance fees. You should budget around $35,000 for combined loan fees.
- Duty to pay back loan. If your situation changes and you need to permanently vacate your home due to medical or other reasons, you must be prepared to pay back the loan.
- Family inheritance. As a reverse mortgage is likely to decrease the amount of equity you have in your property, this means there will be less funds available for your family when you pass away.
How can I use a reverse mortgage?
A reverse mortgage provides you with access to additional funds, which you can use to pay off your mortgage or for a variety of other reasons, such as:
- Debt consolidation
- Purchasing a new property
- Living expenses, such as retirement accommodation or drug expenses
- Home renovation
- Wealth management
- Assisting grandchildren with education fees
What are the types of reverse mortgages?
Reverse mortgages are generally classified into public sector loans and private sector loans, which are outlined below.
Public sector loans
Public sector loans are offered by the government and generally must be used for specific purposes, such as paying for a home repair. The two types of public sector loans include:
- Single purpose reverse mortgage. With the lowest cost structure, single purpose reverse mortgages are generally offered to low income earners that need the funds for a specific purpose.
- HECMS. Home Equity Conversion Mortgages (HECMS) are guaranteed through the Housing and Urban Development (HUD) and can be used for any purpose. HECMs are generally suitable for properties valued at less than $400,000.
Private sector loans
Provided by banks and mortgage companies, private sector loans can be used for any purpose. This type of reverse mortgage is offered as a proprietary loan, which generally offers larger property value limits but can be more expensive compared to public sector loans.
How much am I eligible for?
When deciding how much you may be eligible for, the lender will consider the property value and your age. Generally, you will be eligible for a larger loan amount the older you are and the more your property is worth.
Are reverse mortgages risky?
Regulatory bodies including the US Federal Housing Administration (FHA) and the Department of Housing and Urban Development review the structure and terms of reverse mortgages to ensure that they meet industry standards.
Industry regulation ensures that HECM mortgages are a non-recourse loan, which means that you cannot be held accountable for repayment of any part of the debt. When the property is sold, if the sale proceeds do not cover the debt, the outstanding balance due is waived.
HUD guarantees that your funds are not at risk.
What are the costs?
The costs associated with reverse mortgages can be expensive compared to standard mortgage types, which is why it’s important to carefully review your situation to see if a reverse mortgage if right for you.
Some of the major costs of reverse mortgages include:
- Origination fee. This is the upfront fee charged by the lender to enter into the loan. For HECMs, the origination fee is 2% of the maximum loan amount up to $200,000.
- Mortgage Insurance Premium (MIP). HUD requires all borrowers to take out insurance as a precautionary measure to ensure that you never owe more than the value of your property.
- Appraisal fee. When you take out a reverse mortgage, you’ll need to get someone to estimate the value of your property. The appraisal fee will depend on the pricing structure of the independent expert.
- Servicing fee. The servicing fee is used to cover the administrative cost of maintaining the loan, such as covering the cost of issuing account statements.
Are reverse mortgage proceeds classified as income?
The IRS does not classify reverse mortgage proceeds as income and therefore the proceeds are not subject to income tax. The proceeds also have no impact on your social security or medicare.
Do I qualify for a reverse mortgage?
Generally, to qualify for a reverse mortgage in the US, you’ll need to satisfy the following criteria:
- The youngest borrower must be at least 62 years of age
- You must own the property or be purchasing a property as your primary residence
- The property must comply with FHA appraisal guidelines
- You must have a sufficient amount of equity
Who is a reverse mortgage suited to?
A reverse mortgage is suited to a senior citizen aged 62 years and over who intends to remain in their property throughout their retirement and who needs additional cash flow.
Can I change my mind?
The rescission period is three business days from when you sign the loan documents. This gives you the flexibility to change your mind after reviewing the paperwork.
What happens if a borrower passes away?
If one borrower passes away, the loan is not payable until the surviving borrower moves out of the property or passes away.
In the event that both borrowers pass away, the loan balance is repaid and any remaining equity goes to the borrower’s heirs.
Are there alternatives to reverse mortgages?
When researching different reverse mortgages, you should consider whether this is the best option for you and whether they may be viable alternatives. For example, it may be more convenient to simply sell the home and downsize.
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