Everything You Need to Know About Reverse Mortgages
Note: This is a guest post from Barbara Stucki, Vice President, Home Equity, National Council on Aging.
Most Americans have realized that today’s retirement isn’t what their parents or grandparents had.
Thanks to the Great Recession, millions of older adults are entering retirement with fewer savings, no pensions and skyrocketing health care costs. Others are being forced into retirement before they’re ready thanks to job loss and layoffs. The bottom line is that people are living longer in retirement with less income. According to the Institute on Assets & Social Policy, the number of seniors at risk of outliving their resources has increased by nearly 2 million in just four years. With limited financial options, many older adults are turning to that tried-and-true American asset — their home.
A recent study by MetLife and the National Council on Aging found that 35% of households aged 62 and older have a home loan, many of them reverse mortgages. But is it a good idea to use your home as a source of cash in your retirement? Without a financial game plan to manage this asset, older homeowners may be putting their finances at further risk. Also known as Home Equity Conversion Mortgages (HECMs), reverse mortgages can be a useful financial tool, but they’re not for everyone. Before considering one of these loans, it pays to know the myths and facts.
Myth #1: A reverse mortgage works the same as any other type of home loan.
Truth: A reverse mortgage is a special type of loan for homeowners aged 62 and older that lets you convert a portion of the equity in your home into cash. But unlike a traditional home equity loan or second mortgage, you don’t have to repay the loan until you either no longer live in the home as your principal residence or you fail to meet the obligations of the mortgage. Taking out a reverse mortgage is a big decision, since you may not be able to get out of this loan without selling your home to pay off the debt. You also need to carefully consider your options to avoid using up all the equity you have built up in your house. Learn more about reverse mortgages with NCOA’s free consumer guide.
Myth #2: Most reverse mortgage borrowers use their loan funds for vacations and other fun things.
Truth: The truth is that most borrowers today use their loans for immediate needs, such as paying off their existing mortgage or other debts. About 33% of homeowners who consider these loans want to supplement their monthly income, so they can afford to continue living in their own home longer.
Myth #3: Reverse mortgages are too expensive.
Truth: Taking out any home loan can be costly because of origination fees, third-party closing charges (such as an appraisal, title search and recording costs), and servicing fees. You can pay for most of these costs as part of the reverse mortgage loan. Borrowers who select a traditional HECM Standard reverse mortgage also must pay a hefty upfront FHA mortgage insurance premium that can be as much as 2% of the value of their home. But this insurance guarantees that you will receive the expected loan payments. In addition, you (or your heirs) don’t have to repay more than the value of the home, even if the amount due is greater than the appraised value. The new SAVER HECM reverse mortgage is less expensive because it all but eliminates the upfront insurance fee. However, borrowers get a smaller loan amount with a HECM Saver than with a Standard loan. There are many factors to consider if you are thinking about using your home as a financial resource. You can take a free Quick Check to explore the cost and benefits of tapping home equity through a loan or by selling your house at Home Equity Advisor.
Myth #4: Reverse mortgages should only be used as a last resort.
Truth: It’s never a good idea to make a financial decision under stress. Waiting until a small issue becomes a big problem reduces your options. If you wait until you are in a financial crisis, a little extra income each month probably won’t help. Reverse mortgages are best used as part of a sound financial plan, not as a crisis management tool. If you live on a limited income, there are many public and private benefits that can be an alternative or supplement to a reverse mortgage. You may qualify for help with expenses such as property taxes, home energy, meals and medications.
Myth #5: Most people who take out a reverse mortgage are elderly widows.
Truth: When HECMs were first offered by the Department of Housing and Urban Development (HUD), a large proportion of borrowers were older women looking to supplement their modest incomes, but that has changed. During the housing boom, many older couples took out reverse mortgages to have a fund for emergencies and extra cash to enjoy life. In today’s economic recession, younger borrowers (often boomers) are turning to these loans to manage their existing mortgage or to help pay down debt. Reverse mortgages are unique because the age of the youngest borrower determines how much you can borrow. A challenge is that borrowers deplete home equity as their loan balance grows over time.
Myth #6: A fixed rate reverse mortgage is always a good idea.
Truth: If you’re like most homeowners, you’ve had a traditional 30-year home loan with a fixed interest rate. This allowed you to know how much you needed to budget for mortgage payments each month. However, this conventional thinking does not apply to reverse mortgages, which do not require any monthly payments. There are several drawbacks to HECM reverse mortgages with fixed interest rates. These loans require borrowers to draw all of their funds out at closing, which means they will pay interest on a potentially large sum of money. This could use up your home equity very quickly. An adjustable rate HECM, on the other hand, gives borrowers the option to select a line of credit and only pay interest on what they use. The line of credit may increase over time if interest rates go up, giving borrowers access to more cash.
Myth #7: Reverse mortgage counseling is a waste of time.
Truth: Deciding whether to take out a reverse mortgage loan is challenging. It’s hard to estimate how long you’ll stay in your home and what you’ll need to live there over the long term. Federal law requires that all individuals who are considering a HECM reverse mortgage receive unbiased counseling by an HUD-approved counseling agency. A trained counselor can help you understand the costs and features of different types of reverse mortgage, and evaluate the pros and cons of these loans for your situation. They will also discuss other options including public and private benefits that can help you stay independent longer. It’s valuable to meet with a counselor before talking to a lender, so you don’t get talked into a loan you don’t want or need. Telephone-based counseling is available nationwide, and face-to-face counseling is available in many communities. You can get counseling through NCOA’s HUD-approved Reverse Mortgage Counseling Network by calling 800-510-0301. You can also find a counselor in your area at the HUD HECM Counselor Roster.
Myth #8: Most reverse mortgage borrowers who end up facing foreclosure were scammed.
Truth: It is possible for a reverse mortgage borrower to face foreclosure if they do not pay their property taxes or insurance, or maintain their home in good repair. This is especially a risk for older homeowners who take the entire loan as a lump sum and spend it quickly — perhaps as a last-ditch effort to salvage a bad situation. Those who struggle to pay the bills each month can become overwhelmed by health or other large expenses, making it difficult to keep up with borrower obligations.
Older homeowners may be targets for scam artists who offer too-good-to-be-true real estate or investment deals. Sadly, there are also cases where seniors are talked into a reverse mortgage by family members who want to get their hands on the cash. That’s why reverse mortgage counseling is so critical. The counselor will help you look at the long-term responsibilities of a loan, not just the short-term benefits. Always avoid any unsolicited offers for a reverse mortgage or for help with these loans. If you suspect you or your family have been targeted by a scammer, call 800-347-3735 to file a complaint with HUD.
For more information about reverse mortgages and home equity options for older adults, please visit NCOA at ncoa.org/HomeEquity.
Photo courtesy of the National Council on Aging.