Older homeowners often use reverse mortgages to pay off their traditional mortgages so they can get rid of their monthly house payments. Is that a wise strategy?
Reverse mortgages have gained a bad reputation over the years, but they can be a useful financial tool to seniors when used appropriately, said David Johnson, associate professor of finance at the University of Wisconsin-Superior.
A reverse mortgage is a home equity loan in which the borrower is not required to make payments. The homeowner must be at least 62 years old. A reverse mortgage accrues interest and does not have to be repaid until the homeowner dies or moves out of the house. The Federal Housing Administration calls it an HECM, for home equity conversion mortgage.
Not Only for the Desperate
“Years past, financial planners didn’t view reverse mortgages as a planning tool,” said Johnson, who recently co-authored a study discussing the growing importance of reverse mortgages in retirement. “It was viewed as a last resort and they assumed that the only people that do reverse mortgages are people that are desperate. Clearly that’s not the case, and I think they are starting to view it differently now.”
Why Get a Loan When You Already Have One?
One of the most common reasons homeowners get reverse mortgages is to pay off their existing mortgage so they have more income to worth with, said Maggie O’Connell, who runs ReverseMortgageStore.com. “They already have this debt on the house, so instead of making their mortgage payments they are just paying it out of their equity before they leave the home,” she said.
How to Qualify for a Reverse Mortgage
To qualify for a reverse mortgage, the homeowner must be at least 62 years old and have sufficient equity in the house. The size of the loan depends on the value of the home, the age of the youngest borrower and how much is owed on the house. The owner must pay property taxes, insurance.
How Equity is Cashed Out
With reverse mortgages, homeowners have three options for cashing out equity:
- Receive monthly payments.
- Get a lump-sum payment.
- Maintain a line of credit.
Many homeowners are conservative and just want to eliminate their mortgage payments, but they like having the credit line available, said Beth Paterson, executive vice president of the Reverse Mortgages SIDAC in St. Paul, Minnesota.
“Maybe they don’t need the money right now, but down the line they might have a medical emergency, so it’s good for them to have the option,” she said.
One Borrower’s Experience
That was the case with Barbara Hiebert after her husband died. Their house was mortgage-free, but she knew her retirement income wasn’t enough to cover some of her expenses, including medical emergencies. She got a reverse mortgage but didn’t access the money until she had no other option.
“I rely on it only when I need it,” she said. Recently, she hurt herself after falling and spent more than $10,000 during her at-home recovery.
“I had people come in for three hours in the morning and at night,” she said. “It was expensive. I couldn’t have afforded it without the reverse mortgage.”
What about the kids?
As with many other seniors, Hiebert said she hesitated when she first heard of reverse mortgages because she wanted to leave her condo to her children.
“But they told me, ‘We don’t want you to think like that. We have money to take care of ourselves. We don’t want you to worry,'” she said.
The Name Stays on the Title
In addition to the guilty feeling, some seniors are confused about the process and worry that once they get a reverse mortgage they no longer own the house, Johnson said.
“After they get a reverse mortgage, they still have title,” he said. “They can still do anything they want.”
Once the homeowner dies, the heirs are given the option to pay off the loan and keep the house or sell it to pay off the loan. If the house sells for more than the amount owed, the heirs receive the balance. If the loan is bigger than the loan value, the bank takes all the proceeds, but the balance of the loan does not have to be repaid.
Costs of Getting a Reverse Mortgage
One of the reasons reverse mortgages have gained a bad reputation is because many view them as too costly. But they are no different from conventional mortgages in terms of costs, said Peter Bell, president and CEO at the National Reverse Mortgage Lenders Association.
“It’s still going to be accruing interest on the house the same way as a conventional mortgage,” he said. “The question is whether you are going to be making those monthly payments now or let that be paid off later.”
Borrowers also are required to pay for mortgage insurance when they get a reverse mortgage. As with the interest, the mortgage insurance costs are paid with equity. The insurance protects lenders (not borrowers) from losses.
Understanding Reverse Mortgages is Essential
Because the homeowner isn’t making monthly payments to cover upfront costs, interest and mortgage insurance, the equity on the house can quickly shrink as the loan balance gets bigger over time.
It’s crucial that seniors receive the required counseling before getting a reverse mortgage.
“For consumers, the most important thing they can do is to become educated on how it works,” Johnson said. “A reverse mortgage is not the solution for everybody, but clearly it’s an option for many people and the more information they know, the better they can understand how the product works and they can make an informed decision.”