Time to start a new chapter in your life? A reverse mortgage can be an option if your goals include:
- Getting a degree.
- Helping someone else through college.
- Covering major dental or medical expenses.
- Starting new creative projects or business ideas.
- Enjoying recreation and travel.
- Having funds to tide you over until you qualify for full Social Security benefits.
A reverse mortgage is available to homeowners who have paid off most or all of their mortgages. The name describes a lender’s monthly payments to the homeowner, rather than the reverse.
What to Know Before You Start
Reverse mortgages aren’t only for those who’d like more money to enjoy in retirement. If you have home equity but are short on retirement savings, a reverse mortgage can fill in the gap. And there’s no income tax on the payments.
Reverse mortgages have attractive interest rates, too—although higher than those of a regular mortgage.
There are certain triggering events requiring full repayment. In the two most common situations, the owner dies, or sells the house. Only after the loan payoff is deducted will the owner or heirs receive money from the home sale. Government rules once left life partners in the lurch unless they’d co-signed the reverse mortgage loan. If the borrower died, the government could sell the property. Today, these surviving spouses can stay in the home. The balance due date is paused—as long as the survivor lives there, paying insurance and property taxes.
Popular: FHA Reverse Mortgages and Cash-Out Loans
Be sure to carefully select and work with a reputable lender. The FHA offers a popular reverse mortgage—and an alternative, the cash-out loan.
If you are 62 or older, and the house you’d be using as collateral is your principal residence, you may apply for the FHA’s home equity conversion mortgage (HECM). Units on FHA-approved condo properties can also qualify for home equity conversion mortgages. How much home equity can you tap? This depends on your age, your equity, the total property value, and current interest rates.
An especially valuable aspect of the HECM is the insurance. With the Federal Housing Administration’s insurance, heirs will pay up to 95% of the appraised value, and no more, if the HECM loan debt adds up to more than the home fetches in a sale.
If you pass away, your heirs have six months (plus two possible three-month extensions—so, up to one year) to pay off the loan.
If you still have a mortgage and have a credit score of at least 640, take a look at the FHA’s cash-out refinancing option. It replaces your mortgage with a new one, for a larger amount than your current outstanding balance. The new loan pays off your mortgage, initiates the new mortgage, and gives you the extra funds in a lump sum.
What are the advantages? You can get this before you’re 62. If you plan to live at home well into your golden years, it can help you pay for home modifications. There is no counseling required, and you need not use the home that’s your primary residence.
Note: The federal government lowered its cash-out refinance loan-to-value ceiling from 85% to 80%, as of September 2019.
No Mean Feat: Putting a Reverse Mortgage Together
To get started, you’ll attend an educational meeting with an approved counselor. This preliminary time commitment might sound like a burden, but can be highly beneficial. This adviser can offer important support, helping you find good rates and the right approved lender.
Expect fees: 2% initially, then .5% of the mortgage balance each year. As of this writing, the government caps origination and closing fees at $6,000. Prepare for credit checks, loan-servicing fees, and third-party charges. You’ll need to have the property inspected and appraised. You’ll need to have the title search done. There will be recording fees and mortgage taxes. Oh, my.
Also, lenders expect the borrower to pay a number of charges that borrowers don’t pay directly with a regular mortgage. So, you’ll likely be paying the property taxes and the home insurance.
As you take monthly payments, your HECM balance rises. The larger the loan, and the longer it runs, the more you’ll pay in cumulative interest.
What Are the Options? Alternatives to a Reverse Mortgage
Applying for any mortgage today, reverse mortgages included, means answering calls and questions about income or other proof of ability to pay. As with a regular mortgage application, there can be moments of intense frustration as the process hits glitches.
What are the other ways of tapping into home equity? Of course, you could sell the home and downsize. This option has a lot going for it if your house is just too burdensome to maintain (or if the tax bills are). Some seniors sell to—and then rent their homes back from—a family member or close friend, using the cash received in the sale. The new owner can then qualify for tax deductions on depreciation and upkeep of the rental property.
But if selling is not an option, consider these other financing methods.
The Private Reverse Mortgage
One alternative is for the homeowner to get a private loan, from a close friend or family member, with the senior’s home as collateral. The IRS sets the interest rate for private reverse mortgages, and it’s lower than the bank rate.
And this way, the interest in the home stays with the owner and loved ones.
Family members and close friends of senior homeowners who need access to cash can consider the private reverse mortgage as a way to sweeten the elder’s retirement years.
Home Equity Loans and Lines of Credit
A home equity loan gives the owner a lump sum, so this is a good option when cash upfront is the goal. You do pay interest on the entire loan amount.
There’s also the home equity line of credit (HELOC), through which a homeowner can access funds up to a certain credit limit. A HELOC is more like a credit card: you pay interest only on the funds you actually need and withdraw. Your interest charges will fluctuate, as HELOCs are not fixed-rate loans.
Final Word to the Wise
Use the reverse mortgage safely. Be sure not to fall into arrears with the payments. Keep up with home maintenance, and any work that maintains the value of the home as an asset.
Be sure your estate’s beneficiaries know what to expect. And before you head into any new financing pathways, speak to your estate lawyer to receive situation-specific advice.