A reverse mortgage may seem enticing if you’re retired and struggling with expenses on a fixed income. However, Reverse mortgages may be less appealing upon closer inspection.
Not only are there a number of reverse mortgage scams, but lenders can also impose high fees and closing costs, and borrowers must pay for mortgage insurance. Reverse mortgages can also come with variable interest rates so your overall costs could increase down the road.
If you think a reverse mortgage might help you stay in your home through retirement, make sure you understand the risks and rewards so you can make a better-informed decision.
What Is a Reverse Mortgage?
A reverse mortgage is a lending option that lets homeowners who’ve paid off all or most of their mortgage to tap into their home equity. Reverse mortgage funds, which are only available on primary residences and typically people over the age of 62, are structured as lump sums or lines of credit that can be accessed on an as-needed basis.
With a reverse mortgage, an eligible homeowner borrows money against the equity in the home. The interest accrues on a monthly basis, and the loan doesn’t need to be paid off until you move out or pass away. Instead, accrued interest is added to the loan balance so the figure compounds every month.
If the homeowner moves out before the loan is repaid, there is a one-year window to close out the loan. If the borrower dies, the estate (or heir to the estate) must pay back the loan, but not more than the value of the house.
- Single-purpose reverse mortgage. These reverse mortgages are offered by state, local and nonprofit agencies. They must be used to pay for a specific, lender-approved item. This is typically the most affordable type of reverse mortgage.
- Home Equity Conversion Mortgage (HECM). An HECM is a reverse mortgage insured by the U.S. Department of Housing and Urban Development (HUD). This is the most popular type of reverse mortgage because it does not impose income or medical requirements on the borrower. What’s more, the loan funds can be used for any purpose, and there are several payment options.
- Proprietary reverse mortgage. Proprietary reverse mortgages are reserved for higher-value homes. They are not federally insured and, therefore, do not impose upfront or monthly mortgage insurance premiums.
Reverse mortgages often come with high fees and closing costs, and a potentially costly mortgage insurance premium. For loans equal to 60% or less of the home’s appraised value, this premium typically equals 0.5%. However, if a reverse mortgage exceeds 60% of the home’s value, the premium can increase to 2.5% of the loan amount.
The Good Vs. Bad of a Reverse Mortgage
While a reverse mortgage may seem like a good way to access cash in your golden years, it’s important to understand the realities of this type of loan. Here’s how you can expect to benefit from a reverse mortgage-and what to look out for when comparing this loan option to other alternatives.
The Good
If you’re worried about your ability to cover living expenses or otherwise meet financial obligations, a reverse mortgage can provide the life raft you need.
- A homeowner who might otherwise have to downsize can use a reverse mortgage to stay in her home.
- Loan proceeds can be used to totally pay off an existing mortgage, thus freeing up funds for living expenses.
- Borrowers who comply with lending terms don’t have to make payments until after they move out of the house or pass away.