Article by R. Joseph Ritter, Jr. CFP® EA
Are you or is someone you care about considering a reverse mortgage? Do you have a reverse mortgage and have questions about the terms and costs? Continue reading for answers to these questions and more.
What is it?
A reverse mortgage is a form of debt that is secured by the equity in your home. In that sense, it is similar to a traditional mortgage, except for how the money is provided by the bank. In a traditional mortgage, the bank gives you a lump sum of money, commonly up to 80% of the equity in your home. In a reverse mortgage, you receive installment payments on the total amount the bank is willing to lend. A reverse mortgage is similar to obtaining a home equity line of credit (HELOC) and then drawing on the HELOC from month to month and could be thought of as exchanging the equity in your home for an annuity.
If you obtain a $50,000 HELOC, only the amount you draw needs to be paid back, so if you draw $5,000, then you owe the bank $5,000 (with interest). This is how a reverse mortgage works. The bank approves you for a loan which is secured by the equity in your home and then pays you so much per month. Each monthly payment you receive has to be paid back (with interest) at some point.
Reverse mortgages are not, however, without expense and are not necessarily the best option in all cases.
Do I qualify?
Reverse mortgages are available to senior citizens age 62 and older who own their primary residence. Federally insured reverse mortgages can only be written on a value of no greater than $625,000. Your home could be worth more, but only the first $625,000 is counted.
You must have sufficient income or assets available to maintain your home. This includes insurance, taxes, property association dues, and maintenance. FHA which insures most reverse mortgages requires certain repairs and ongoing maintenance to homes. If you have ever used an FHA mortgage to buy a home, then you have probably been through some of the basic maintenance FHA requires before they will make a loan. If you fail to pay the insurance, taxes and maintenance, you could be in default, and the reverse mortgage would then become due and payable, even if you continue to live in the home. In the event of a default in these circumstances, you may be forced to sell your home to pay the mortgage if you cannot refinance or afford to pay off the mortgage with other assets.
How does it work?
Reverse mortgages offer payment in several different ways. You can receive all of the money in a lump sum, monthly installment payments for a fixed term (such as 10 years), monthly installments for as long as you occupy the home, line of credit on which you can draw when you need money, or in some cases a combination of these options. All of the money you receive must be paid back to the bank just as you would pay a traditional mortgage, plus the lender’s costs and expenses specific to reverse mortgages.
As long as you remain in your home and do not default on the mortgage, there is never any money due back to the bank. The bank collects the money due when you permanently leave the home, which is at your passing, sale of the home, permanent relocation or an absence of more than 12 months. If you are married, the surviving spouse can remain in the home without having to pay back the mortgage until he or she vacates the home.
Unless you have other assets available to pay off the mortgage when it becomes due and payable, your home will need to be sold, and the proceeds will be used to satisfy the mortgage. The good news is that the reverse mortgage is non-recourse, which means that the bank cannot take more than the value of the home to pay towards the balance of the mortgage if the balance due exceeds the value of the house. The bad news is that when the mortgage becomes due the balance could very well exceed the value of your home, which means that your family, heirs and beneficiaries would not receive your home or any equity in it, and you would not have any equity on which to rely if you are transitioning into a life care facility.