A reverse mortgage allows seniors to obtain a loan by using their home as collateral. It’s a popular choice that provides cash to help homeowners with living or housing expenses, and it can help seniors to remain in familiar surroundings. However, sometimes, rather than getting a reverse mortgage it is best to explore other ways to mitigate costs such as downsizing to a smaller house.
Weighing the pros and cons of getting a reverse mortgage can lead to a more informed decision. Below are the key factors to consider.
Not every senior homeowner is eligible for a reverse mortgage. Applicants must be at least 62-years-old, and they must have a sufficient amount of equity in the home. Further, the house must be appraised, and the applicant’s credit will be reviewed.
Senior homeowners can choose from three types of reverse mortgages.
Single-purpose reverse mortgages are usually for low- and moderate-income homeowners, and are offered by local and state government agencies or nonprofits. The lender determines how this type of reverse mortgage can be used (for example, to pay property taxes or for repairs to the house).
Proprietary reverse mortgages are offered by private companies. Homeowners with higher-value homes can benefit from this type of mortgage since they can usually borrow more money with this option.
Home Equity Conversion Mortgages (HECMs) are offered by the federal government.
Max Austin, a Huntsville, Alabama-based reverse mortgage specialist and wholesale account specialist at New South Mortgage, says there are multiple ways for senior homeowners to receive payments:
A lump sum at closing
Monthly tenure payments, as long as the home is the primary residence
Advances through a growing credit line if the reverse mortgage is an adjustable rate loan
Any combination of these three options
Since reverse mortgages are FHA-insured, Austin says the associated fees or closing costs are typical and comparable to a traditional FHA mortgage. He explains that the costs used to be considerably higher, but competition and market pressures played a role in lowering them. “Home equity lines of credit often have less closing costs as they are often held privately by banks and credit unions instead of larger national lenders,” says Austin.
4. Interest rates
Reverse mortgage interest rates can be fixed or adjustable, according to Austin. Since adjustable rates can increase, the amount owed on the home can also increase. However, Austin says, “The adjustable option also allows for a growing line of credit for the senior borrower while the fixed rate does not have the line of credit feature.”
Also, interest payments are added to the loan balance each month. Nevertheless, Austin says that the senior homeowner or their heirs can make interest payments to keep the loan balance from increasing.
5. Existing Mortgages
Any existing mortgages or liens on the property must be paid off as part of the reverse mortgage loan closing. Ideally, paying off these items eliminates any monthly payments. “This can greatly increase cash flow each month especially when many seniors are on a fixed income from their social security and/or other investment distributions,” explains Austin.
6. Payments/Taxes/Yearly Fees
Senior homeowners do not have to make monthly mortgage payments. However, as with other types of mortgages, the homeowner is responsible for paying property taxes and homeowner’s insurance. Austin says there is no escrow account as part of the reverse mortgage, so seniors would need to set aside adequate monies to pay these items each year.
“As of April 27, 2015, a new requirement for reverse mortgages went into effect called a ‘financial assessment’ which requires an income and credit history review in order to demonstrate the borrower’s ability to handle their financial obligations, mainly their insurance and property taxes,” says Austin.
He explains that borrowers who don't meet the financial requirements for a reverse mortgage may have the option of setting aside money from the loan, which will be used to pay the insurance and taxes in the future. Also, Austin says that some borrowers will qualify for a “partial set-aside” if their credit is strong, but they don't meet the income requirements.
Senior homeowners also need to perform routine maintenance, so the home doesn’t lose its value. If they are not current with their taxes and insurance, and the house is not maintained, the mortgage company can ask for repayment of the loan.
Seniors don’t have to pay taxes on the money they receive from a reverse mortgage. Austin says these payments are not considered income and therefore, not taxable.
Also, Social Security and Medicaid payments are not affected in most situations.
7. Equity/Loan Balance
As the years progress, it’s possible that the senior homeowner may either spend all of the money they received from the reverse mortgage, or they may outlive their equity. If this happens, it’s not possible to take out another equity loan on the property. On the other hand, it’s also possible that the senior homeowner will outlive the loan.
8. Moving Out of the House
If the senior homeowner has to move out of the home for a period lasting over one year, all bets are off. For example, if the homeowner goes to live in a nursing home or assisted living facility, the balance of the mortgage is due, or the company can take possession of the house.
However, if the senior homeowner has a spouse who was not a co-signer, this individual can continue living in the house if they pay property taxes, insurance, and upkeep.
According to Austin, “In August 2014, the Department of Housing and Urban Development revised their policies to allow for the transferring of the reverse mortgage benefits to a surviving non-borrowing spouse after the borrowing spouse passes away.” Before this recent change, Austin says the non-borrowing widow or widower would have to find another place to live and potentially face foreclosure.
Once the remaining borrower has passed or moves from the property, Austin says the heirs have several options depending on how much equity is in the property.
The heirs can keep the property, which would entail paying off the balance owed either from their own funds or by refinancing the existing mortgage.
The heirs can sell the property, and they would be able to keep any proceeds from the sale after the reverse mortgage is paid off.
The heirs can walk away if the property has little to no equity or is ‘upside down’ which means the balance owed is greater than the value of the home, Austin says the heirs can give the keys to the lender and walk away. And he says the loan is “non-recourse” so the heirs will never owe more than the property is worth.
The Bottom Line
A reverse mortgage is a popular option for seniors who want to live in their home without the burden of a mortgage payment. However, sometimes selling the property and moving to a smaller house may be a better solution. In any event, it’s important to critically evaluate if it is best to get a reverse mortgage.