Written by Ronald Scaglia: firstname.lastname@example.org Friday, 06 July 2012 08:30Money to go on a vacation, make home repairs, pay for medical expenses or simply to have in order to enjoy a comfortable retirement. Furthermore, it’s tax-free and doesn’t affect Medicare or Social Security. It sounds like a great deal, at least according to the commercials promoting the benefits of getting a reverse mortgage. However, before you sign on the dotted line, seniors should be well informed of what a reverse mortgage is and all of the benefits and consequences of getting one.
“You need to be thoughtful,” says Ira Rheingold, executive director of the National Association of Consumer Advocates. “This is not a panacea. This is not free money. You’re basically taking the equity out of your home. You’re not going to be able to use the money for anything else.”
A reverse mortgage allows senior homeowners, aged 62 and above, to take a loan against a portion of the equity that they’ve built up in their homes. The money may be taken as a lump sum, in monthly payments, or as a line of credit. Unlike traditional mortgages, payments are not required to be made until after the homeowners either pass on, or are no longer living in the home as their primary residence. The loan may also be called if the borrowers do not fulfill the obligations of the mortgage, such as by not paying property taxes, failing to maintain it, or not insuring it.
Just as with a traditional mortgage, the appraised value of the home affects how much money may be borrowed in a reverse mortgage. Simply put, the higher the appraised value, the more funds that can be borrowed. As with a traditional mortgage, the current interest rate also is a significant factor. The lower the interest rate, the more that may be borrowed.
However, unlike a traditional mortgage, other factors come into consideration. One major detail is the age of the homeowner, and more specifically, the age of the youngest borrower. Younger homeowners are expected to live longer and therefore it will most likely be a longer wait before the lending company receives payment on the loan. During this period, interest charges would continue to accrue. Therefore, younger borrowers will receive less money than comparable homeowners who are older.
“The older you are, reverse mortgages work better,” says Rheingold. “So if you’re an 80-year-old, and you have equity in your house for $300,000, and your life expectancy is to 85, then they’re going to look at the present value of your house, what your house is worth, what it might look like in five or six years and you can get more money out of it. But if you’re 60 years old, you’re going to get a lot smaller amount because you have another 25 years to live.”
For some senior homeowners, a reverse mortgage is quite practical. Most experts agree that reverse mortgages are a good option for those who have a great deal of equity in their homes and wish to remain living there but have a limited income. For those who may not be able to secure a traditional home equity loan because their low incomes would prevent them from making the payments, a reverse mortgage may be a viable, and in some cases, the only option. Since payment on a reverse mortgage is due when the homeowners no longer use the home as their primary residence, reverse mortgages work best for those who plan on staying in their homes for a long time, ideally, for the rest of their lives.
“The benefit of reverse mortgages is they allow older Americans, those 62 and over, to tap into the value of their home, in order to provide monthly income,” says Gerri Walsh, vice president of investor education with The Financial Industry Regulatory Authority (FINRA), the largest independent regulator for all securities firms doing business in the United States. “If that’s the use that you would put the money [to], then that might be the right choice for you. You have the asset – your home. You’ve accumulated a lot of wealth in your home. A reverse mortgage allows you to tap into that wealth without having to sell the home.”
“A reverse mortgage is for the person that wants to stay in their house, doesn’t have a ton of resources, and really wants to take the equity out because they have no intention of leaving it to anybody,” adds Rheingold.
Of course, if reverse mortgages are as rosy as the commercials with celebrity spokespeople present them, every homeowner would dash off to a lending company on their 62nd birthday to complete a deal. There are considerations.
One is these is the impact on heirs. If a homeowner wants to leave a home to children or other beneficiaries, a reverse mortgage complicates this. The heirs to an estate can choose to satisfy the mortgage and retain the home, but all the expenses that have accrued during the duration of the loan must be paid back. On the positive side, the heirs to an estate cannot incur debt from a reverse mortgage, even if the value of the home has declined significantly in value.
“Realize that money comes at a price and at the end of the day, this is not something you’re going to be able to leave to your heirs,” says Rheingold.
Another consideration is the possibility of relocation. A reverse mortgage becomes due when the homeowners no longer live in the home as a primary residence. So, if homeowners decide to move, the payment on the reverse mortgage becomes due. In addition, physical ailments, which may not be foreseen, can also be an issue. If the primary homeowners are out of the home for 12 consecutive months, the reverse mortgage could be called.
“There are restrictions on how reverse mortgages can be used,” says Walsh. “So, if you’re not planning to stay in your home, either because you are thinking of moving or downsizing, or it’s likely that you will have a medical need that will require you to be in assisted living for a period of time, longer than a year, that also can impact you. The lender may be able to take your home. That’s something that you have to consider.”
Property taxes, insurance expense and maintenance costs on the home should also be considered when determining whether a reverse mortgage is a good option. Even though the lender will have a first lien on a home with a reverse mortgage, and may get all of the proceeds from the sale of that home in the future, the borrower still owns the home and is responsible for all of these.
Homeowners should also realize that once they tap the equity in their home, it is not available to be used again. Those who choose a lump sum have to be very cautious when doing their budgeting. It may be nice to turn the equity to cash and go on a fascinating six-month vacation to Europe, and not have to withdraw any money from a savings account to do so. However, that equity will not be available for medical costs or other future expenses once it is depleted.
“It’s not free money,” says Rheingold. “There are consequences. It can work for a certain person but you need to be that certain person. It works if you’re cash poor and house rich, and you’re older.”
One more consideration is the expense of reverse mortgages. Some reverse mortgages have high-up front costs, higher interest rates, or additional fees. These can go unnoticed because borrowers do not directly pay these, as they are instead taken out of the money received. However, they reduce the amount of funds received as compared to other loan products.
“It’s an expensive product,” advises Rheingold. “Up front it’s expensive to start with. The initial costs of reverse mortgages are pretty high. It doesn’t come out of pocket but it’s an expensive mortgage.”
According to Walsh, FINRA has seen instances where salespeople have tempted homeowners to take a reverse mortgage and then use the proceeds of that loan to invest in an annuity or other investment product. That can be quite dangerous. In addition, Walsh says that this defeats the purpose of reverse mortgages, which are supposed to supplement income. If the money is quickly invested, and then in a worst case scenario, declines or dwindles to nothing because of that investment, it is completely counterintuitive to the purpose of taking a reverse mortgage in the first place.
“If the person that’s promoting the reverse mortgage is then suggesting that you turn around and invest the proceeds…that’s really a red flag,” says Walsh.
Walsh advises that homeowners use FINRA’s broker check tool to make sure an investment professional is licensed. In addition, a check can be done to see if an individual or a firm has a history of complaints or regulatory actions against them and if they have been charged with violating the rules.
Homeowners should also be aware that they are required to speak with a counselor. Reverse mortgages are the only mortgages for which this is required, according to Rheingold.
For those who need cash, but believe that a reverse mortgage is not the right option, another possibility is a home equity line of credit. With this product, homeowners borrow money against the equity in their home and then make monthly payments. When the entire amount borrowed, plus interest, is paid back, the homeowners once again has complete ownership the home, provided there are no other liens. They can then once again borrow against that equity and, eventually, leave the home to their heirs.
“It could definitely be a much better option,” says Bob Lund, vice president of residential lending with Bethpage Federal Credit Union. “Home equity lines, traditionally, are free (except for returning the principal and paying the interest). The lender, in most cases, pays for the transaction fees.”
Lund adds that in addition to having lower expenses, home equity lines of credit are advantageous in that borrowers may only access the funds they need and therefore pay interest on a smaller amount. In addition, he also says, as payments are made, the homeowner’s equity in the home rises and thus, the money could be borrowed again, if needed.
As for the risks, one consideration is that home equity lines of credit come with adjustable interest rates. Currently, interest rates are at historical lows, but if the rates do increase, the interest expense would also increase.
Rheingold also cautions that homeowners should not consider a home equity line of credit if they do not have the means to make the required payments. He says those who are in that financial situation might be better off with a reverse mortgage.
“It’s better than taking a home equity loan if you don’t have the money to pay it back because you’re just going to lose your house,” he says.
However, Lund counters that a credit check is performed on those seeking a home equity line of credit and that those who do not demonstrate an ability to pay back a line of credit would not be granted one.
Deciding on whether a reverse mortgage is right is an individual decision. Homeowners have to consider many factors including whether they want to leave their home to their heirs, if they plan on moving, the expense of the loan, and the imperativeness for which they need the money. Depending on each individual situation, it could be the right decision or a disastrous one.
“My advice, in many ways, is to be very thoughtful about it,” advises Rheingold. “Think about what your needs are. “