The Truth About Reverse Mortgages
Have you ever considered getting a reverse mortgage? If so, you’re not alone. Many of today’s retirees and older homeowners have thought about this type of mortgage. While it is a convenient way to tap into the value of your home, it also comes with certain complications and drawbacks that consumers need to be aware of before signing on the dotted line.
Below, we discuss the different types of reverse mortgages and how they can be structured, what are the tradeoffs for homeowners, and some alternatives to a reverse mortgage that people should know about.
How to Qualify and How to It Works
First, it’s important to remember that a reverse mortgage is still a loan, like other mortgages. But it works very differently than a traditional mortgage. That’s because the purpose of a reverse mortgage is to allow the homeowners to use their home equity while they continue to live in the home.
You can think of it as the opposite of when you buy a home and get a traditional mortgage. In a traditional mortgage, you pay the lender monthly so you eventually own more and more of the home outright.
In the case of a reverse mortgage, the lender pays you (all at once or over time) and collects interest on the money it loaned you, which transfers more and more of your home equity to the lender as time goes on.
In order to qualify for a reverse mortgage, you must be at least 62 years old and your home must be worth more than your primary mortgage and any other mortgages on the property. You also must live in the home and have the ability to pay all property taxes and insurance on it. Finally, you must not be delinquent on any federal student loans or other federal loans.
How a Reverse Mortgage is Structured
You should understand that there are different types of reverse mortgages (including jumbo reverse mortgages for homes valued above a certain threshold), but the most common one is referred to as a HECM or home equity conversion mortgage.
Usually a reverse mortgage or HECM is structured so that you receive payments in one of three ways:
- Lump sum payment: You can choose to get all the money at the beginning. This option usually comes with a fixed interest rate, and interest will be charged on the full amount of your loan every month, which can add up.
- Monthly payments: You can choose to receive monthly payments from the lender. Each payment increases your loan balance, and interest is charged on the balance as time goes on. The monthly payments are usually guaranteed for a certain term (i.e. 10 years) or for as long as you live in the home.
- Line of credit: You can have an open line of credit that allows you to pull out money as needed. Whatever you pull out is added to your loan balance and you will be charged interest on it.
- Hybrid: You can also choose a combination of monthly payments and a line of credit, which gives you added flexibility.
Of course, each payment structure comes with different costs and rules, so it’s imperative that you ask your lender to thoroughly explain all the options before choosing one. The amount you can borrow in a reverse mortgage depends on a number of factors including your age and your home’s value.
Advantages and Disadvantages of a Reverse Mortgage
There are both advantages and disadvantages to a reverse mortgage. The benefit of a reverse mortgage is that it allows you to use your home equity without giving up the right to live in the home. That can be very convenient for people who are retired and have medical expenses. The flexibility that a reverse mortgage offers is very appealing for lots of different situations.
However, there are drawbacks. First, the origination fees charged to you when you take out a reverse mortgage can be very high. You may also wind up paying a lot of interest on the loan, depending on how much you borrow and at what interest rate. There are also ongoing servicing fees which add to your loan balance. Overall, this all adds up and can be quite costly.
Perhaps the biggest disadvantage to a reverse mortgage is that it will often prevent your heirs from inheriting the home (unless they have lots of money available to pay off the loan). If you pass away or move out of the home, the entire balance will come due and in most cases that means the home will have to be sold to pay back the loan.
Alternatives to a Reverse Mortgage
When trying to decide if a reverse mortgage is a good fit for you, you should know that there are alternatives to getting a reverse mortgage. Below, we discuss a few of the most common alternatives and how they work:
Home Equity Loan or HELOC: A home equity loan or HELOC has some similarities to a reverse mortgage, but the structure is different. With a home equity loan, you get a lump sum of money and agree to pay it back in monthly payments. A HELOC on the other hand, is a line of credit, where you can borrow what you want when you want, up to your credit limit. Your home is your collateral on the loan. Learn about the differences between a HELOC and home equity loan here.
Cash-Out Refinance: A cash-out refinance entails swapping your current mortgage for a new (larger) mortgage. The difference between the old mortgage and the new mortgage is the amount you get to take out of your home’s equity — in cash. In some cases, you can get this cash out relatively quickly. One of the other benefits of this type of loan is that you might also be able to lock in a lower interest rate. However, there are some complicated rules for getting a cash-out refinance and not everyone can qualify for a cash-out refinance. You’ll need a particular credit score and amount of equity to get approved by a lender. A cash-out refinance is not a good idea for everyone.
Homeownership Investment: A third alternative is to do a home ownership investment with a company like Unison. With the Unison HomeOwner program, the company invests alongside you in your home, allowing you to unlock some of the equity in your home. In return, they receive a share of any future change in the value of the home at the time you sell it. Unlike a loan, you do not need to make monthly payments. Nor are there interest charges. For those who want to tap into home equity without monthly payments, this can be a good option.