How Does A Reverse Mortgage Work?
Reverse mortgages help retired homeowners access a portion of their equity during retirement. The principle can be drawn by the homeowner:
- in a lump sum,
- by receiving monthly payments for a specified term or over their lifetimes (if the mortgage is joint),
- or a revolving line of credit.
While it is a mortgage the promise to repay the loan doesn’t come due until the last homeowner leaves the home. They can also be required to repay the loan if they fail to meet any provisions within the mortgage contract.
Do I qualify for a reverse mortgage?
- at least one borrower must be 62 or older
- the owners must occupy the home
- there aren’t any minimum loan amounts
- There are no credit requirements
- proceeds aren’t subject to income tax
- borrowers must take an FHA approved counseling class (ensures the applicants completely know what a reverse mortgage is)
- the maximum loan can’t exceed $625,000 (varies by county)
How much can I borrow on a reverse mortgage?
The loan size is determined by:
- the borrower’s age,
- the home/county lending limit, and
- interest rate of the program selected.
The program selected can range anywhere from a line of credit (maximizes money available), lump sum (provides cash immediately), or monthly payments (set up by the Department of Housing and Urban Development or HUD).
When is the loan due?
The loan is due when one of three scenarios occurs:
- either the borrower dies,
- sells the property, or
- moves out for an extended period of over 1 year.
The borrower (or heirs of the property) then has a few options. They can refinance and keep the property, sell and cash out the equity, or turn the home over to the lender. If the home is returned to the lender the borrower/heirs have no further claim to the property. They also forego any equity associated with the home.
What can you use your reverse mortgage for?
Before you accept the funds from a reverse mortgage it will be reduced by costs and fees. The amount you borrow goes towards:
- paying off current mortgages on your home
- origination fees or commissions (as high as 2% of the loan amount)
- mortgage insurance premiums (as high as 2% of the loan amount)
- service release premiums and loan correspondent fees
- recording fees, appraisal fees, and other closing costs
- repair rider fees and set-asides
- just about anything else your retirement dreams call for!
Keep in mind even after you take a reverse mortgage you’re required to maintain your home. You’re also required to pay normal and necessary homeowner expenses. Those expenses are the same you’re currently paying however, things like HOA fees, property taxes, and homeowners insurance. Should you fail to maintain the home in good faith the lender can force you out or to repay the loan.
How to use a reverse mortgage
Currently I have no clients utilizing a reverse mortgage. Generally clients want to leave their homes to their heirs. I’ve found however for many clients assuming a reverse mortgage is a “failsafe” can make sense.
For example, Clients John & Jane Doe have certain monthly obligations during retirement. Those expenses are quite a strain on their financial plan (i.e. they’re spending more than they really should). They also plan on reducing those expenses over the next 5 to 10 years as they travel less and purchase fewer new vehicles.
Their current plan isn’t “confidence inspiring”. In fact it’s entirely likely they’ll run out of money.
By assuming the potential use of a reverse mortgage they’re able to enjoy – or “front-load” – their retirement now while they’re still young. Creating a retirement plan with a reverse mortgage as a back-stop can help retirees enjoy life more now knowing they have an asset they can liquify later if necessary.
As with any financial or investment planning strategy, careful consideration must be given to the downsides of such events. In this case, the Doe’s may very well end up leaving their children nothing or very little. For some clients this is perfectly acceptable, for others it’s not.
Summarizing reverse mortgages as a retirement planning tool
For the most part reverse mortgages are tools which should only be used in an emergency situation. They’re the backstop that allows many retirees to maintain dignity and self-sufficience. You should make every effort to avoid using what is most clients largest asset – their home.
That being said, there’s no shame in considering a reverse mortgage as a viable retirement strategy. If you’re pushing your plan to the brink and haven’t considered a reverse mortgage, first consider whether you should cut back your retirement expenses or not! Next consider building in a reverse mortgage as the last line of financial defense in retirement.