Take a New Look at Reverse Mortgages
If you think reverse mortgages are just the last resort income source for desperate retirees, think again!
In the past, reverse mortgages were the fodder for late night TV commercials and garnered a bad reputation. Now, with recent changes to federal rules governing reverse mortgages, they have become part of retirement income strategy for middle-class seniors. Reverse mortgages are a variation of home equity loans. The difference is that repayment of the loan and interest is not due until the borrower(s) and spouse die, sell the home or permanently move out of the home. Recent changes in federal rules allow the spouse to stay in the residence, but the simplest way to make sure is to have the spouse listed as a borrower. If the property is sold after the death of the borrower(s) and spouse for less than the loan balance, the heirs are not responsible for the debt. If the home sale price exceeds the loan balance, the borrowers (or their heirs) are paid any surplus. Heirs also have the option to pay off the mortgage and retain the property. Borrowers keep the title to their home throughout the life of the reverse mortgage and this serves as collateral for the loan. Interest is charged only on money they receive and then accumulates over the life of the loan, until the repayment occurs.
There are several types of reverse mortgages. Single Purpose Reverse Mortgages are offered for seniors with very low incomes by some non-profit organizations and state and local agencies. Because the federal government does not insure these loans, the monthly insurance premiums of some reverse mortgage types are not charged, which could save up to $10,000 over the life of the loan. This mortgage can only be used for lender-specified purpose like repairs or property taxes. Proprietary Reverse Mortgages are underwritten by private lenders and are also not eligible for federal insurance. They are more expensive and appeal to homeowners with property values over $679,650, the limit of HECM mortgages. Home Equity Conversion Mortgage for Purchase (H4P) reverse mortgage loan is used to buy a property using the equity from your current home. You can use this to make a monthly payment on a new house to downsize or upsize during retirement. The federal Home Equity Conversion Mortgage (HECM) reverse mortgage loans are made by private lenders under a program administered by the Department of Housing and Urban Development (HUD). Tighter requirements help circumvent default and foreclosure problems of the past. Loans are a percentage from 50-75% of the home’s current appraised value. They vary according to the borrowers’ age and the current interest rate. You can take out only 60% of the home’s value in the first year. New rules also allow the unnamed spouse to remain in the home, if it is still the person’s primary residence.
You must be at least 62 years old and own your home as your primary residence to qualify for a Home Equity Conversion Mortgage (HECM) reverse mortgage. A small previous home loan could be paid off by the reverse mortgage. There are some private lenders who offer Proprietary Reverse Mortgages for 60-year-old seniors. You must have the financial ability to pay all property taxes, homeowner association fees, and maintain the home. Since April 2015, new laws require lenders to review the capacity and willingness of borrowers to pay the taxes, fees and maintenance. Part of the loan may be held in reserve to cover these expenses. HECM reverse mortgage loans contain no restrictions on how the borrower uses the money.
Keep in mind that there can be loan origination fees, mortgage insurance on HECM mortgages, title fees, home appraisal cost, wire fee, credit report, and flood certificate costs. Some lenders offer lower costs, so shop fees and rates.
Why are more seniors considering reverse mortgages now? Seniors who want to supplement their income, pay for long- term care, remodel their home to “age in place”, to travel, or to improve the sustainability of their retirement income strategy may find that a reverse mortgage is a great option. Reverse mortgage loans can help reduce the need for investment portfolio withdrawals due to market downturns, provide income to delay social security benefits until age 70, to fund taxes due to converting traditional IRAs or 401(k)s to Roth IRAs, provide larger inheritances for your heirs, and could help pay for unexpected expenses.
A reverse mortgage line of credit loan can be used to buffer the fluctuations of the market by providing income and allowing the investment portfolio income to be spent in years of positive returns. Coordinating the use of portfolio income to fund living expenses with income from a reverse mortgage loan allows seniors to make the most of market conditions.
Social Security benefits increase each year by 6.5% to 8%, if you delay claiming benefits until age 70. This can be a valuable option in financial planning by providing “bridge” income from age 66 to 70, when a higher Social Security monthly benefit can be claimed. The income from a reverse mortgage loan is not considered taxable income and does not affect Social Security or Medicare eligibility, but may affect Medicaid and other low-income program eligibility.
You have to pay taxes upfront to provide tax-free income in the future when traditional IRAs or 401Ks are converted to Roth IRAs. You could potentially save significant taxes in the long run with this strategy.
Your heirs may think that the upfront costs and compounding interest of a reverse mortgage will reduce their inheritance. This is not necessarily true. Using the reverse mortgage to create income instead of income taken from an investment portfolio of stocks could produce a larger inheritance. If money remains or is added to the investment portfolio, more money could be generated than in a single asset of a home. Home values may plummet. With a reverse home mortgage, your borrowing capability continues to grow, providing retirement income.
If you take out a reverse mortgage line of credit in early retirement, the line of credit grows and could surpass the value of the home when it may be most needed in later retirement years. You may require income for medical expenses, long term insurance payments, long term care, or financial support of a family member. Long term care at home is better suited to reverse mortgage loans. You may not be allowed to keep a reverse mortgage if you spend more than a year in nursing home care.
Reverse mortgage loans have higher upfront costs than Home Equity Line of Credit (HELOC). You may be better off with a HELOC loan. Make a sample budget of different types of mortgages at different rates to see which meets your needs best. If you plan to stay in your home or sell in 5 years or more, the reverse mortgage may make sense. Overall fees are coming down, so research your options carefully. The National Reverse Mortgage Lenders Association Lender Locater and the U.S. Department of Housing and Urban Development Lenders List have the contacts for banks and institutions offering reverse mortgage. Recommendations from your CPA or financial professional and reviews of lenders in the Consumer Financial Protection Bureau’s Consumer Complaint database can further guide you. Reverse mortgage counselors, who can’t recommend specific lenders, can help you navigate the reverse mortgage loan process.
Your professional financial advisors can give you advice on what makes the best sense for your particular situation. It is reassuring to see the information for comparing reverse mortgage deals improving as baby boomers retire and consider these mortgages as a financial tool.
If contacting a company for more information, make sure you let them know if you will pay the fees yourself or include them in the loan balance. Happy reverse mortgage shopping!