A reverse mortgage is a specialized type of mortgage available only to homeowners who are age 62 and older. When comparing to traditional mortgage, this type often works in reverse. Homeowners who qualify for this type of mortgage are able to benefit from the equity they have built in their home. Though there are some fees, there are no required monthly payments. The loan balance is often repaid with proceeds from selling the property, whether this happens due to the death of the borrower, a move, or simply deciding to sell the home.
Types of reverse mortgages
There are a few types of reverse mortgages that are available to homeowners today. The first is known as the single-purpose reverse mortgage. This is offered by some local government agencies and non-profit organizations. When a homeowner gets this type of loan, it is with an intended purpose in mind. Some purposes might include paying for home repair costs, additions and renovations, or even property taxes.
Another type of reverse mortgage is known as a proprietary reverse mortgage. Homeowners who can qualify for this type of mortgage typically have a home that has a higher appraised value. This is typically a private loan provided by a mortgage lender.
The third, and most common, type of reverse mortgage is the federally-insured type – a Home Equity Conversion Mortgage, or HECM for short. By setting up this type of mortgage, the homeowner can use the funds for any purpose they choose.
Benefits of a reverse mortgage
Many Americans today are surprised at the difficulty of living on a fixed retirement income. Sources of additional income may become increasingly limited as health declines during that time. Many homeowners face the gut-wrenching decision of selling their home, just to access the equity they have built over the years, or staying in the home and wondering how to keep up with the costs of owning it now that they are retired. A reverse mortgage gives some homeowners the ability to stay in their home and use the equity they have built up to help with monthly expenses.
When homeowners obtain an adjustable rate (ARM) reverse mortgage early in retirement, the unused funds will grow over time in the borrower’s favor. For this reason, some homeowners look to obtain one early in retirement when the funds are not needed, Many such HECM clients find that the line-of-credit funds can act as an emergency fund and even pay for in-home care later in retirement if needed.
Risks to a reverse mortgage
1. Loan balances tend to rise
There are no required monthly payments on a reverse mortgage. Therefore, unless voluntary prepayments are made the loan balance will rise. While the reverse mortgage may take pressure off the homeowner’s other retirement assets, the heirs will need to refinance the reverse mortgage if they wish to keep the home. Otherwise, the heirs may need to sell the home to satisfy the reverse mortgage. However, whatever equity remains in the home, is kept for the heirs. Regardless, it might be a good idea to discuss your decision of setting up a reverse mortgage with future heirs so they can plan accordingly.
2. Home repairs, taxes, and homeowners insurance
The homeowner will still need to take financial responsibility for any home repairs, property taxes, homeowners insurance, and any other property-related charges. While homeowners can use their reverse mortgage line of credit to help pay for these property expenses, they are still the homeowner’s responsibility and not the lender’s. By reviewing typical home costs over the last 5-10 years, homeowners can make sure that their cash flow will be adequate to cover these types of expenses.
The reverse mortgage can be a tremendous lifeline for those with limited cash flow in retirement. But like any form of retirement cash flow, there are advantages as well as costs. Take the time to get educated and make the right decision for your own personal situation.