Thousands of Baby Boomers are hitting retirement age each year, but many are not financially prepared for the next 20+ years of life. Rising healthcare costs, food costs and inflation are siphoning off seniors’ hard-earned retirement funds faster than expected. A reverse mortgage could be the solution.
Seniors who own their homes can obtain money for living expenses by tapping into the equity in their homes through a reverse mortgage.
What is a reverse mortgage?
A reverse mortgage allows homeowners 62 years and older to withdraw some of their home’s equity and obtain money for living and other expenses without selling.
These mortgages can cut expenses and increase income by eliminating monthly mortgage payments and depositing funds into the senior’s accounts. Additionally, because it is considered a loan, reverse mortgage proceeds are not subject to income tax, in most cases.
“A reverse mortgage allows seniors to reduce the amount going out to maintain their home and stay in the home until they pass or move away without paying principal and interest payment,” explains Russell Graves, Executive Director and a HUD Certified Housing Counselor at the National Foundation for Debt Management. “They’re still paying the property taxes and insurance, but the principal and interest payments get added on to the loan. So, it shrinks equity in the home and increases debt.”
This can be a smart strategy for seniors who struggle to get by month to month or who want to tap into their largest asset to finance portions of their lives.
Who can qualify for a reverse mortgage?
Specific borrowing guidelines must be met to obtain and keep the mortgage.
1 – Borrowers must be over the age of 62. Reverse mortgages are specifically geared to help seniors afford life in retirement. If the original borrowers are both over 62, they can tap the benefits, even if one spouse dies. Those under 62 cannot be on the reverse mortgage loan or access benefits if the borrower dies. However, protections have been enacted for qualifying non-borrowing spouses.
2 – The homeowners must fully own or own a significant portion of their home. The U.S. Department of Housing and Urban Development (HUD) requires the home to be owned outright or a considerable portion of the mortgage to be paid to receive a government-insured mortgage.
3 – Homeowners must continue to pay property taxes, homeowners insurance and homeowners association (HOA) dues. They must also properly maintain the home as part of the mortgage agreement terms. If homeowners submit payments late or fall behind on these bills or if they let the home fall into disrepair, they risk foreclosure.
4 – The home must be the homeowner’s and the eligible spouse/partner’s primary residence. Primary residence means you must live there for at least six months and one day out of the year.
5 – Reverse mortgage applicants or borrowers may not have delinquent federal debts, like overdue taxes.
6 – The home must meet all FHA property standards and flood requirements.
7 – Seniors interested in a reverse mortgage must attend a mandatory counseling session with a Home Equity Conversion Mortgage (HECM) counselor approved by HUD. Many FCAA members provide this service.
Common types of reverse mortgages
There are three types of reverse mortgages. This article focuses on the most common type – the Home Equity Conversion Mortgage (HECM).
Almost all reverse mortgages are issued as an HECM. These loans are some of the safest loans because they are insured by the Federal Housing Administration (FHA), according to Todd Christensen, Housing Counseling and Education Manager at Debt Reduction Services. Because of this federal insurance, they typically have lower interest rates.
The FHA insures two types of mortgages: fixed rate and adjustable rate.
Fixed-rate
Fixed-rate reverse mortgages work by distributing funds in a one-time lump sum through a payment at the closing of the loan.
“It’s the smallest financial benefit of a reverse mortgage, but it can still be significant,” said Christensen.
Adjustable-rate
Adjustable-rate reverse mortgages distribute funds in five different ways:
- Line of credit – This option allows you to draw funds at any time, for any reason. It is the most popular option, according to Christensen.
- Tenure – This option delivers monthly payments as long as you or your eligible spouse live in the home. This is the least common option chosen.
- Term – This option delivers set monthly payments for a set period of time.
- Modified tenure – This option provides fixed monthly payments along with a line of credit as long as the borrower resides in the home as his/her primary residence.
- Modified term -This option offers a fixed monthly payment for a predetermined time period and access to a line of credit as long as the home remains the borrower’s primary residence.
Reverse mortgage pros and cons
Reverse mortgages offer many benefits to seniors, but they also have drawbacks. Before pursuing one, realistically consider what you expect the future to look like.
“If you intend to downsize your home in the next five years, it may not make sense to get a reverse mortgage and pay the high upfront costs,” said Graves. “If you move within in a short period of time, you will have less equity and more debt. When you pay off the home you’re in, you’ll get less money back which could make it harder to downsize.”
Graves stressed the importance of looking at the whole picture, especially considering the unexpected.
“There’s no doubt that insurance rates will go up,” he said. “You can’t control the cost of construction, cost of repair, cost of insurance. You have to be able to cover those things. You can go into this with a great plan, but in the end, you have to be very realistic about the costs that may come up.”
Benefits of a reverse mortgage
No more monthly mortgage payments
“There is no more monthly payment with a reverse mortgage. Ever. As long as that home is your primary residence for the year,” said Christensen. “The relief of not having a monthly mortgage payment is the biggest advantage of the reverse mortgage. So, having access to a line of credit feels like a bonus.”
The ability to maintain your lifestyle using the equity in your home
“Seniors today went through the last four years of financial uncertainty with the pandemic and everything else. Many don’t have the income, equity or investments to weather the next 20 years,” said Graves. “So using their house as a backstop, using their equity in their home, allows them to maintain a certain lifestyle they have earned. That could be a good reason for the reverse mortgage.”
Allows you and your eligible spouse to remain in the home even if the loan balance exceeds your house’s value
The balance on a reverse mortgage grows over time and can potentially exceed the value of your home.
Because of the non-recourse limit, the debt you must repay will never surpass the value of your property. Thanks to insurance provided by the FHA, homeowners and eligible spouses do not have to pay back the money until they move out of the house, pass away or fail to maintain obligations. Lenders cannot make claims against any of your or your heirs’ other assets.
Security for your spouse if you are to pass away
“The qualified, non-borrowing surviving spouse may continue to reside in the home as long as they continue to maintain the loan obligations, like taxes and insurance. So, even if one of the two occupants passes, the other one can stay in the home,” said Graves.
Allows seniors to age in place, and the cost may be less than buying a different home
Aging in a home with high equity can be less expensive than competing with first-time home buyers for a smaller home with a potentially higher interest rate. When you consider the costs of moving and a potentially higher interest rate, moving may not make sense.
Potentially easier for your heirs to deal with after your death
“I spoke with a gentleman just last month whose parents had a reverse mortgage, and he was now getting one. He said, ‘You know, when our last parent died, the home was worth less than what they owed on it,’” said Christensen. “But he said it was actually very simple and very stress-free for the surviving children.”
“The son said, ‘We gathered at the home and looked for what was of emotional and financial value for us. Then we walked out and closed the door. And the lender then took over everything else.’”
Heirs have options for repaying the loan
Your heirs have a few choices to repay the loan.
They can:
- Pay back the loan in full (at limited market value) and keep the home,
- Sell the home and keep the remaining proceeds, or
- Walk away / surrender the house to the lender. When the reverse mortgage balance exceeds the home’s value, the FHA will pay the difference, not the heirs.
You only have to live in the home for six months and one day out of the year.
The rest of the year, you can travel or live elsewhere.
Downsides of a reverse mortgage
You must meet the mortgage requirements and pay property taxes and homeowners insurance, as well as maintain the home, or you risk foreclosure
Some municipalities have programs to freeze taxes for seniors, but not all do. However, you cannot combine a Property Tax deferral program with a HECM Reverse Mortgage loan.
Also, expect insurance to rise, especially in disaster states like Florida and California.
“Once people reach 65 years of age, the average life expectancy is about 20 years longer,” said Graves. “Twenty years is a long time to live in a home and not have enough money to keep it up.”
Erosion of equity leaves less inheritance for your children and could cause problems if they live in your home
“Always understand that a reverse mortgage is eroding your equity faster than the value of your home is increasing,” said Christensen. “It will decrease the amount of any inheritance you plan on leaving your children.”
When the borrower leaves or passes away, anyone living in the home must repay the mortgage or surrender the home. The exception is for eligible spouses who are on the reverse mortgage.
Not everyone qualifies for a reverse mortgage
You must meet the qualifications listed above to obtain a reverse mortgage.
Reverse mortgages are expensive
“It’s the most expensive mortgage out there,” said Graves. “It has the most fees attached to it. However, that fee is part of the guarantee that allows you to stay in the home after your equity has been used up.”
You could potentially jeopardize other benefits or become ineligible for other programs
The income obtained from a reverse mortgage could violate asset or income restrictions for Medicaid or Supplemental Security Income (SSI) and jeopardize your eligibility for benefits. However, HECM reverse mortgages do not affect Social Security retirement benefits or federal Medicare. To learn more, talk to a HUD counselor like many of FCAA’s members.
Your spouse cannot be on the mortgage if he/she is under 62 years of age
Since reverse mortgages are intended for seniors, those under 62 years of age at the time of the mortgage origination cannot obtain one or reap the benefits.
How FCAA members can help
FCAA members are non-profit educational organizations that provide unbiased advice and resources to help seniors determine their options so they can make educated decisions. As part of the application process, all reverse mortgage applicants must meet with a HUD-certified and approved housing counselor to ensure they understand the program.
“FCAA members bring an added perspective and overall financial picture,” said Christensen. “We have experience with financial education and debt counseling. We bring a lot more than just, ‘Here’s your certificate. Let’s check the boxes.’”
“One of the things that has happened is seniors are retiring with debt more and more every day. They’re trying to figure out how to pay the credit cards, the car loan, the house note and all those things,” said Graves. “They have to take a real clear look at what they have and what they need to do. Housing counselors are a wonderful choice for that. On a daily basis, we help people right size their life to give them options going forward.”
Contact an FCAA member today to discuss if a reverse mortgage is right for you.