If you’re 62 or older – and looking for money to finance a home improvement, pay off your current mortgage, supplement your retirement income, or pay for healthcare expenses – you may be considering a reverse mortgage. It’s a product that allows you to convert part of the equity in your home into cash without having to sell your home or pay additional monthly bills.
The Federal Trade Commission (FTC), the nation’s consumer protection agency, wants you to understand how reverse mortgages work, the types of reverse mortgages available, and the risks involved.
In a “regular” mortgage, you make monthly payments to the lender. 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. The loan is repaid when you die, sell your home, or when your home is no longer your primary residence. The proceeds of a reverse mortgage generally are tax-free, and many reverse mortgages have no income restrictions.
Three types of reverse mortgages:
- single-purpose reverse mortgages, offered by some state and local government agencies and nonprofit organizations
- federally-insured reverse mortgages, known as Home Equity Conversion Mortgages (HECMs) and backed by the U. S. Department of Housing and Urban Development (HUD)
- proprietary reverse mortgages, private loans that are backed by the companies that develop them
Single-purpose reverse mortgages are the least expensive option. They are not available everywhere and can be used for only one purpose, which is specified by the government or nonprofit lender. For example, the lender might say the loan may be used only to pay for home repairs, improvements, or property taxes. Most homeowners with low or moderate income can qualify for these loans.
HECMs and proprietary reverse mortgages may be more expensive than traditional home loans, and the upfront costs can be high. That’s important to consider, especially if you plan to stay in your home for just a short time or borrow a small amount. HECM loans are widely available, have no income or medical requirements, and can be used for any purpose.
Before applying for a HECM, you must meet with a counselor from an independent government-approved housing counseling agency. Some lenders offering proprietary reverse mortgages also require counseling. The counselor is required to explain the loan’s costs and financial implications, and possible alternatives to a HECM, like government and nonprofit programs or a single-purpose or proprietary reverse mortgage. The counselor also should be able to help you compare the costs of different types of reverse mortgages and tell you how different payment options, fees, and other costs affect the total cost of the loan over time. To find a counselor, visit www.hud.gov/offices/hsg/sfh/hecm/hecmlist.cfm or call 1-800-569-4287. Most counseling agencies charge around $125 for their services. The fee can be paid from the loan proceeds, but you cannot be turned away if you can’t afford the fee.
How much 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, and current interest rates. In general, the older you are, the more equity you have in your home, and the less you owe on it, the more money you can get.
HECMs generally provide bigger loan advances at a lower total cost compared with proprietary loans. But if you own a higher-valued home, you may get a bigger loan advance from a proprietary reverse mortgage. So if your home has a higher appraised value and you have a small mortgage, you may qualify for more funds.
What are the risks of a reverse mortgage?
If you’re considering a reverse mortgage, be aware that:
- Lenders generally charge an origination fee, a mortgage insurance premium (for federally-insured HECMs), and other closing costs for a reverse mortgage. Lenders also may charge servicing fees during the term of the mortgage. The lender sometimes sets these fees and costs, although origination fees for HECM reverse mortgages currently are dictated by law. Your upfront costs can be lowered if you borrow a smaller amount through a reverse mortgage product called a “HECM Saver.”
- 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 as the loan funds are advanced to you and interest on the loan accrues.
- Although some reverse mortgages have fixed rates, most have variable rates that are tied to a financial index: they are likely to change with market conditions.
- Reverse mortgages can use up all or some of the equity in your home, and leave fewer assets for you and your heirs. Most reverse mortgages have a “nonrecourse” clause, which prevents you or your estate from owing more than the value of your home when the loan becomes due and the home is sold. However, if you or your heirs want to retain ownership of the home, you usually must repay the loan in full – even if the loan balance is greater than the value of the home.
- Because you retain title to your home, you are responsible for property taxes, insurance, utilities, fuel, maintenance, and other expenses. If you don’t pay property taxes, carry homeowner’s insurance, or maintain the condition of your home, your loan may become due and payable.
- Interest on reverse mortgages is not deductible on income tax returns until the loan is paid off in part or whole.
According to a Reuters news report, the most popular reverse mortgage loan type is the Home Equity Conversion Mortgage (HECM), which is administered and regulated by the U.S. Department of Housing and Urban Development, and insured by the Federal Housing Administration.
Repayment typically is triggered when a homeowner dies or moves out permanently, and is typically funded through sale of the home. If the balance on a HECM is higher than the value of the home, the FHA makes up the difference. The theory is that using this method the you can stay in your home without making payments until you die or decide to leave.
However, a growing number of borrowers are taking on reverse mortgage loans at younger ages in return for large lump payouts that carry high fixed rates of interest. And a growing percentage of these outstanding loans are at risk of default, says the CFPB.
Borrowers may think that taking a fixed-rate loan is the best way to go. According to the experts fixed rate lump sum loans rack up higher interest costs and deplete borrowers’ equity far more rapidly.
While reverse mortgages may offer seniors in need a useful way to tap home equity, the CFPB found that reverse loans are too complex for most seniors to understand. Many struggle to understand the rising balance and falling equity structure of the loans, or do not understand that reverse mortgages really are loans.
Who should consider a reverse mortgage?
Only those over age 70 with plenty of equity value in their homes should consider a reverse mortgage. For women that age consideration should probably be much later, maybe age 80 since women outlive men and we all are generally living longer.
Indeed, if you decide to go with a reverse mortgage use an adjustable rate loan and only withdraw what you need over time, not in a lump sum. Taking a lump sum loan leaves you with “no flexibility or cushion,” say CPFB advisers.
Be sure you really understand what you’re getting into before signing any papers. Especially if the loan agreement changes who has title to your home. Click here for CFPB tips on reverse mortgages.
Some of these loan agreements may mean the borrower ends up owing more than the value of the equity in their homes. When they die, the kids have to come up with the difference. Oops.
When looking at a reverse mortgage get good outside financial advice before doing any deal or signing anything.
Talk to an elder law attorney, a financial adviser or an accountant. Family members may NOT be the best source of advice since they may like the idea of tapping into your assets as an early inheritance. In this economy everybody is just scraping by including many younger family members.
Personally, it bothers me that former U.S. Sen. Fred Thompson (R-Tenn.) is hawking reverse mortgages on national television on behalf of American Advisers Group, a private lending company. Fred Thompson should have better things to do. AAG was sued this year (2012) by Illinois Attorney General Lisa Madigan for unfair and deceptive marketing practices to solicit seniors for reverse mortgages.Massachusetts gave AAG a cease-and-desist order for deceptive marketing practices, according to Jim Newell, writing at gawker.com.
The TV ads that I’ve seen remind me of the Countrywide mortgage loan ads from five years ago. We know how that all turned out. Thompson’s ad for AAG claims these “government-backed” loans can be made at “no risk.” That’s a joke. Fred, you should be embarrassed.
The federal financial protection bureau is out this month with a new warning that seniors are taking reverse mortgages too early, do not understand the agreements and are ending up defaulting on these loans. They then lose their homes and have no money other than Social Security to live on into their real old age. Ugh.
Portions of this article plus additional information is available from The Federal Trade Commission