Financial decisions are crucial for anyone leaving the workforce behind to begin their golden years, when traveling, attending Little League games and doting on grandchildren become more top-of-mind than ever.
But those things are not always an option for retirees. Maybe a disability has rendered a loved one homebound, or maybe living on a lower monthly income has become more difficult — and with higher costs — than planned. Perhaps retirees become low on cash, potentially struggling to pay for basic needs like food and medicine. Senior citizens are often bombarded with ideas and plans to stretch their money to help pay for necessities. One of the solutions suggested to seniors by financial planners and lenders is a reverse mortgage, a loan administered by the Department of Housing and Urban Development that allows homeowners age 62 and older convert their home equity into cash. It becomes due when the borrower moves, sells, passes away or fails to pay property taxes or homeowners insurance or maintain the property.
Reverse mortgages were once considered taboo by financial advisors, especially when mortgages and lenders were not as closely regulated as they are today. But there are instances in which a reverse mortgage may be a benefit, says Stephanie Yates, Ph.D., the Regions Institute for Financial Education Endowed Professor in the University of Alabama at Birmingham’s Collat School of Business. Homeowners who have a significant amount of equity and find themselves in cash-strapped situations can consider exploring a reverse mortgage to help ease their financial burden.
“If you are equity rich and cash poor, and plan to live in your current house for a long time, a reverse mortgage is certainly something to consider,” Yates said. “It’s a way to turn the value of your home into an income stream without having to sell the property or repay a loan every month. In the right situation, it can increase a retiree’s financial profile and positively affect their quality of life.”
The Federal Housing Administration’s Home Equity Conversion Mortgage — a reverse mortgage commonly referred to as HECM — was first introduced in 1990. The loan reached its peak in popularity in 2009 with more than 114,600 reverse mortgages executed. The number of reverse mortgages declined to 48,902 in fiscal year 2016, according to HUD.
To best understand how reverse mortgages work, think of it as a mirror image of a regular mortgage. A person or couple 62 or older who qualifies for a reverse mortgage can borrow against the value of their home; but instead of paying the bank, the bank pays them. And at the end of the deal, it is the bank — not the couple or the heirs — that owns the home if the money borrowed is not repaid either through refinancing to a traditional mortgage, selling the home to repay the loan, or paying what is owed in a lump sum.
“That is the No. 1 reason anyone considering a reverse mortgage should consult with their children or heirs as part of the decision-making process,” Yates said. “A lot of children might be banking on getting that house when their parents die. If the parents make a decision to do a reverse mortgage, the children may get the house after they die; but there is little or no equity in it.”
Indeed, once a reverse mortgage is signed, the homeowner can draw down their home equity without repaying it as long as they live in their home. The money can be loaned up front or paid out monthly; but the interest is deferred until the last surviving borrower dies, sells the home, or no longer lives in the home as a principal residence — for instance, if they have to move to an assisted-living facility.
But as soon as the homeowner no longer permanently lives in the home, the loan is to be repaid in full, with interest.
“That’s when the homeowner, if they are still alive, or the heirs have to make the decision to either sell the home if it’s viable based on what is owed and how much the home is worth, refinance to pay back the loan and keep the home, or make a lump sum payment to keep the home,” Yates said. “That’s why homeowners considering a reverse mortgage should talk with their heirs. It could be that the discussion is ‘how important is the home to the family’ versus ‘what are our current needs in our golden years, and is a reverse mortgage the best solution for those needs for everyone in the family.’”
Reverse mortgage fine print
Among the uses for a reverse mortgage are:
Paying off an existing mortgage (required as part of the loan)
Reducing credit card debt
Paying everyday bills
Affording medical expenses or in-home care
Repairing the home
Setting it aside for potential emergencies
There are instances in which a reverse mortgage is not the best option.
If one cannot maintain the costs associated with the home — even without a monthly mortgage payment — a reverse mortgage is probably not best, Yates says. Spending the equity on your home diminishes the value of the estate, leaving even less to pass along to heirs. According to the Federal Trade Commission, there are other things to consider as well:
There are fees and other costs: Higher than average closing costs, determined by the value of the home, also are typical for reverse mortgages. These include origination fees, appraisal fees and upfront mortgage insurance. The interest rate paid on the loan is also generally higher than that of a traditional mortgage.
“Because of high upfront costs, a reverse mortgage is usually not a great option if you’re borrowing a small amount,” Yates said. “You might pay far less by taking out a home-equity line of credit, or you could generate more income by selling and moving to a less expensive place, if that is feasible.”
You owe more over time: As you receive your payments, interest is added onto the balance you owe each month. Therefore, the amount you owe grows as the interest on your loan adds up.
Interest rates may change over time: Most reverse mortgages have variable rates, which are tied to a financial index and change with the market. HECMs, however, offer fixed rates and are what Yates strongly recommends. HECMs tend to require you to take your loan as a lump sum at closing.
Interest is not tax-deductible each year: Interest on reverse mortgages is not deductible on income tax returns — until the loan is paid off, either partially or in full.
You pay other costs related to your home: You keep the title to your home when you have a reverse mortgage, which means you are responsible for property taxes, insurance, utilities, fuel, maintenance and other expenses.
What happens to your spouse? With HECM loans, if you signed the loan paperwork and your spouse did not, in certain situations, your spouse may continue to live in the home even after you die if he or she pays taxes and insurance, and continues to maintain the property. But your spouse will stop getting money from the HECM, since he or she was not part of the loan agreement.
What can you leave to your heirs? Reverse mortgages can use up the equity in your home, which means fewer assets for you and your heirs. Most reverse mortgages have something called a “non-recourse” clause. This means that you, or your estate, cannot owe more than the value of your home when the loan becomes due and the home is sold. With a HECM, generally, if you or your heirs want to pay off the loan and keep the home rather than sell it, you would not have to pay more than the appraised value of the home.
The federal government requires those who are interested in a reverse mortgage to meet with a financial counselor before the loan is approved.
“Reverse mortgages are complicated, but they are beneficial in some cases,” Yates said. “It’s important that seniors considering this communicate — talk with their heirs and meet with a financial planner. Discuss in detail your financial situation, what you see as your roadblocks or hardships, and determine the best course of action.”
More information on HECMs for seniors is available at hud.gov, including the Office of Housing Counseling. For a rigorous analysis of determining whether you are better off with a reverse mortgage or a less-expensive home, find a fee-only financial planner at napfa.org.