By Carrie Schwab Pomerantz
Money & You
With all the news about the housing crises, loan defaults and home foreclosures, borrowers are definitely becoming aware of the pitfalls of overextending themselves. I'm continuously receiving questions about the best way to approach a mortgage and how handling debt, particularly mortgage debt, fits into an overall financial plan.
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View More Most Popular Categories... One question that seems to be coming up more frequently is whether a reverse mortgage makes sense for older homeowners who want to increase cash flow. Apparently, reverse mortgages — first introduced in 1988 — are becoming increasingly popular. According to an AARP study, consumer awareness is up and the median age for borrowers is down from 76 to 73. And as the boomer generation reaches 62, the age of eligibility, the market for reverse mortgages is expected to increase dramatically.
On the surface, a reverse mortgage can seem like a low-risk way for homeowners to tap into their equity for retirement needs, long-term care costs, or even to avoid foreclosure. Dig a little deeper and you'll find there are many factors to consider, from high fees to family inheritance issues. If you or someone you're close to is thinking about a reverse mortgage, I strongly suggest you start with these general facts and carefully consider the pros and cons before making a decision.
The upside
A reverse mortgage is a loan against your home that you don't have to pay back as long as you live there. Instead of making payments to a lender, the lender pays you. Since the money you receive is a loan, not income, it's income tax-free.
The amount you qualify for depends on your age (you must be at least 62), the interest rate and, of course, the equity you have in your home. Other factors include the location of your home and the borrowing limits set by vendors. But all things being equal, the older you are when you take out the loan, the more money you can receive.
You can take the cash from a reverse mortgage in a lump sum, monthly payments, a standby line of credit or a combination of all three, and you don't have to repay the loan as long as you live in the house. If you move - whether you sell or keep your home and rent it out - or when you die, the reverse mortgage loan must be paid off. However, the amount owed, including interest, will never exceed the value of the house. If there's any money left over, say your house appreciates faster than the cost of the reverse mortgage, you or your estate can keep the difference.
Sounds pretty good so far, right? So what's the catch?
The downside
One of the biggest drawbacks to a reverse mortgage is cost. The upfront closing costs and loan origination fees can be 8 percent to 10 percent of the loan limit. That's equivalent to paying 8 to 10 points on a conventional mortgage loan.
Plus, it's important to realize that, even though you don't have to repay the loan until you leave the house, you're still incurring debt. If your home value appreciates fast enough — a big "if” these days — that appreciation could offset some of your borrowing costs. But in most cases the amount you owe (your loans plus interest) grows over time, while your equity declines. And don't forget that you're still responsible for the ongoing costs of maintenance, insurance and real estate taxes.
Another possible drawback is family disharmony. Do the kids expect to inherit the house? If so, they might be upset to discover the bank owns a substantial portion, or even all, of your home. Be sure to talk to your heirs if you plan to take out a reverse mortgage. Granted, they'll want what's best for you in the long run, but it's always wise to avoid surprises.
The alternatives
A reverse mortgage should never be the centerpiece of your retirement plan, but it can make sense for some people. For instance, if you're older, intend to remain in your home for a long time and have limited retirement savings, it could be a good way to supplement your income. It also may serve as a viable option for cash-strapped seniors who might otherwise be forced to leave their homes.
If you or a loved one decides the benefits of a reverse mortgage outweigh the drawbacks, you have a few choices for loans. The loan limits and fees vary by provider, so be sure to research them thoroughly. Options to explore include:
•Federally Insured Home Equity Conversion Mortgage: This loan is insured by the U.S. government. Loan limits vary by county and currently range from $200,160 to $362,790.
•Fannie Mae "Home Keeper” Mortgage: Also federally insured, it offers a higher loan limit than an HECM, currently up to $417,000.
•A private lender: Costs may be higher, but you may be able to get a larger loan.
Reverse mortgages aren't for everyone. In fact, because they're often considered a "financial tool of last resort,” it pays to explore other ways to generate cash from your home. A home equity line of credit might be a practical alternative. Even though you'll have to repay the loan.
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