Get the Facts Before Cashing In On Your Home’s Equity
Whether seeking money to finance a home improvement, pay off a current mortgage, supplement their retirement income, or pay for healthcare expenses, many older Americans are turning to “reverse” mortgages. They allow older homeowners to convert part of the equity in their homes into cash without having to sell their homes or take on additional monthly bills.
In a “regular” mortgage, you make monthly payments to the lender. But in a “reverse” mortgage, you receive money from the lender and generally don’t have to pay it back for as long as you live in your home. Instead, the loan must be repaid when you die, sell your home, or no longer live there as your principal residence. Reverse mortgages can help homeowners who are house-rich but cash-poor stay in their homes and still meet their financial obligations.
To qualify for a reverse mortgage, you must be at least 62 and live in your home. The proceeds of a reverse mortgage (without other features, like an annuity) are tax-free, and typically have no income restrictions.
Three Types of Reverse Mortgages
The three basic types of reverse mortgage are:
- Single-purpose reverse mortgages, which are offered by some state and local government agencies and nonprofit organizations;
- Federally-insured reverse mortgages, which are known as Home Equity Conversion Mortgages (HECMs), and are backed by the U. S. Department of Housing and Urban Development (HUD); and
- Proprietary reverse mortgages, which are private loans that are backed by the companies that develop them.
Single-purpose reverse mortgages generally have very low costs. But they are not available everywhere, and they only can be used for one purpose specified by the government or nonprofit lender, for example, to pay for home repairs, improvements, or property taxes. In most cases, you can qualify for these loans only if your income is low or moderate.
There are costs involved with obtaining a reverse mortgage. In most cases, however, these costs can be included with the loan and does not require money to be paid at closing. Since the costs are a one-time fee, the longer a person stays in the home, the more affordable these costs become.
Once you have met with a reverse mortgage specialist, you will be required to meet with a counselor. The counseling is provided by independent government-approved agencies and is at no cost to you. The purpose of the counseling is to ensure that you understand the program and are making your own, well informed decision. Your reverse mortgage specialist can assist you in finding a counselor in your area.
The amount of money you can borrow with a HECM or proprietary reverse mortgage depends on several factors, including your age, the type of reverse mortgage you select, the appraised value of your home, current interest rates, and where you live. The older you are, the more valuable your home, and the less you owe on it, the more money you can get.
You may receive your proceeds from a HECM loan in the following manners:
- As a lump sum at closing
- As monthly payments to you
- As a line of credit
- As a combination of the above
The proprietary program usually works best for people with homes valued at $500,000 plus and who are in their mid-seventies or higher. Your reverse mortgage specialist can assist you in determining if the HECM, Fannie Mae, or a proprietary loan is best for your needs.
Reverse mortgage loan advances are not taxable, and do not affect Social Security or Medicare benefits. You retain the title to your home and do not have to make monthly repayments. The loan must be repaid when the last surviving borrower dies, sells the home, or no longer lives in the home as a principal residence. In the HECM program, a borrower can live in a nursing home or other medical facility for up to 12 months before the loan becomes due and payable.
As you consider a reverse mortgage, be aware that:
- Lenders generally charge origination fees and other closing costs for a reverse mortgage. Lenders also may charge servicing fees during the term of the mortgage. The government caps what fees can be charged to a borrower.
- The amount you owe on a reverse mortgage grows over time. Interest is charged on the outstanding balance and added to the amount you owe each month. That means your total debt increases over time as loan funds are advanced to you and interest accrues on the loan.
- Reverse mortgages may have fixed or variable rates. Most have variable rates that are tied to a financial index and will likely change according to market conditions.
- Reverse mortgages can use up all or some of the equity in your home, leaving fewer assets for you and your heirs. A “nonrecourse” clause, found in most reverse mortgages, prevents either you or your estate from owing more than the value of your home when the loan is repaid.
- Because you retain title to your home, you remain responsible for property taxes, insurance, utilities, fuel, maintenance, and other expenses. So, for example, if you don’t pay property taxes or maintain homeowner’s insurance, you risk the loan becoming due and payable.
- Interest on reverse mortgages is not deductible on income tax returns until the loan is paid off in part or whole.
Getting the Best Rates
If you are considering a reverse mortgage, shop around to compare your options and the offered terms. Learn as much as you can about reverse mortgages before you talk to a counselor or lender (see links below). It will help you ask more informed questions, which could lead to a less expensive reverse mortgage.
- If you want to make a home repair or improvement or need help paying your property taxes, you may want to find out if you qualify for any low-cost single-purpose loans that may be available in your area. Area Agencies on Aging (AAAs) generally know about these programs. To find the nearest agency, visit www.eldercare.gov or call toll-free, 1-800-677-1116. Ask the AAA for information about available “loan programs for home repairs or improvements,” or “property tax deferral” or “property tax postponement” programs.
- If you are interested in a federally-insured HECM, know that all HECM lenders must follow HUD rules, and that many of the loan costs including the interest rate will be the same no matter which lender you select. Still, some costs including the origination fee, other closing costs, and servicing fees may vary among lenders.
- If you live in a higher-valued home, you may be able to borrow more from a proprietary reverse mortgage. But it generally will cost more. The best way to see key differences between a HECM and a proprietary loan is with a detailed side-by-side comparison of future costs and benefits. Your reverse mortgage specialist can provide you with this side-by-side comparison.
- No matter which type of reverse mortgage you are considering, be certain you understand all the conditions that could make the loan due and payable. Ask a counselor or lender to explain the Total Annual Loan Cost (TALC) rates, which show the projected annual average cost of a reverse mortgage, including all itemized costs.
Source: Federal Trade Commission, Active Minds research