This month, the Federal Reserve increased interest rates. However, rates remain at historic lows, making it difficult for many retirees to generate sufficient income. Even worse, 41 percent of Americans aged 55 to 64 have no retirement savings. Given the headwinds facing older Americans, it is not surprising that reverse mortgages have been growing in popularity. But buyers need to beware.
At first glance, a reverse mortgage might look like an easy and obvious solution. By converting your home equity into a recurring cash flow, you can stay in your home and receive regular monthly payments that are typically tax-free and will not impact your Social Security or Medicare benefits. You don’t have to repay the mortgage so long as you live in your home: payment is due only once you die, sell your home or move out. If you have spent your entire life building equity in your home, it only feels right to use that equity to fund your retirement. According to the acceptance requirements compiled by MagnifyMoney, you need to be 62 or older and the home should be your primary residence. You also need to have the financial resources to continue to meet obligations such as property taxes, homeowner’s insurance, association dues, and repairs.
Any time you see stars advertising easy money on cable television, you need to ask some critical questions before signing on the dotted line. While a reverse mortgage might be appropriate for some people, the product comes with significant risks and high costs. You should do extensive research before taking out a reverse mortgage. To help, here are at least five questions that every person considering a reverse mortgage should ask themselves.
1. Are you willing to sell your home and move to a much cheaper property?
The easiest and cheapest way to get access to your home equity is to sell your property. If you have been in your home for a long time and it has appreciated significantly in value, retirement might be the perfect time to downsize and save the difference. A reverse mortgage typically has a number of fees that will be charged upfront and over time. According to the CFPB, “upfront costs include lender fees, upfront mortgage insurance, and real estate closing costs. Costs over time include interest and ongoing mortgage insurance premiums.” Most importantly, these fees and costs tend to be “more expensive than other home loans.”
If you are able to sell your home and pay cash for a much smaller, less expensive property with the proceeds, you will be able to eliminate most of the costs associated with a reverse mortgage, which can be significant.
However, you might not be able to find a cheaper property, or might not want to move. In those cases, make sure you ask yourself the next four questions.
2. What about your spouse?
One of the most common complaints to the CFPB about reverse mortgages comes from surviving spouses. For Home Equity Conversion Mortgages (HECM) originated prior to August 4, 2014, many non-borrowing spouses found themselves at risk of foreclosure upon the death of the borrowing spouse. Fortunately, HUD issued new rules that make it much easier for a non-borrowing spouse to remain in the property if the borrowing spouse dies. However, there are some conditions, and you should speak with your HUD counselor to fully understand what would happen when the borrowing spouse dies. If you are taking out a non-HUD (non-HECM) reverse mortgage, make sure you talk about what happens to a non-borrowing spouse in the event of the death of the borrowing spouse. With some advance planning and discussion, you can ensure that there are no surprises later.
3. What about your heirs?
A reverse mortgage could eat up a significant portion of your home’s value, reducing the value of your estate. Leaving money to your children or favorite charity might be less important than fully funding your retirement. Just make sure you do the math and realize the implications that a reverse mortgage will have upon any inheritance your children might be expecting.
It is important to note that a reverse mortgage line of credit, when used in combination with your investment portfolio, might actually help your portfolio when used strategically. Recent research indicates that using an HECM line of credit during negative equity return years can be an effective tool to avoid withdrawals during downturns. But you need to have a strategy (and do some math) in advance, rather than just using the HECM as another way to get more cash throughout your retirement regardless of market forces.
4. Can you afford the homeowner’s insurance, taxes and upkeep?
To qualify for a reverse mortgage, you will need to prove that you have the ability to make your homeowner’s insurance, tax and upkeep payments. Failure to keep the taxes current and insurance premium paid could ultimately lead to foreclosure and loss of home.
5. Have you done a thorough job comparison shopping for the right reverse mortgage?
There are three types of reverse mortgages: single-purpose reverse mortgages, proprietary reverse mortgages and Home Equity Conversion Mortgages (known as HECMs). Single-purpose loans tend to be the cheapest, and are offered by some state and local government agencies as well as non-profit organizations. Proprietary loans are backed by private companies and typically offer higher potential loan amounts. HECMs are federally-insured and are backed by the US Department of Housing and Urban Development. HECMs are usually cheaper than private loans, and you can start your search by meeting with a HUD HECM housing counselor. You can find a list of counselors at HUD’s website. You shouldn’t pay someone to introduce you to a HUD counselor: you can make the appointment yourself, for free.
As you do your comparison shopping, beware sales people with high pressure tactics. This is your home and retirement you are putting on the line: you should take your time, do the research and speak to a wide variety of people and lenders before making any decision.
Please note: this post was updated on December 22, 2016 to reflect the HUD policy changes that make it possible for a non-borrowing spouse to remain in the property after the death of the borrowing spouse.
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