Reverse mortgages are a hot topic among retirees. Some retirees want to have access to a reverse mortgage for financial security, while others are still unsure of how they feel because of some of the practices in the industry in the 60s, 70s and 80s that gave these types of mortgages a bad name.
If you’re considering a reverse mortgage, it’s important to know what these mortgages offer you, their benefits and your obligations when taking out a reverse mortgage.
Traditional vs Reverse Mortgage
A traditional mortgage is what you likely used when you purchased your home. You’ll go through a mortgage company that has a lien on your home and will have to pay the mortgage note for 15, 20 or 30 years (terms can vary).
When you make a payment, you’ll be paying down your principal and interest.
Reverse mortgages are different because there are no payment obligations, but there will be a lien against the property. The loan will be paid at some time in the future where interest and principal are repaid, but the loan has no monthly obligation.
Since a reverse mortgage is only allowed for someone 62 or older, the lender often only recuperates their money when the last borrower passes away and the home is sold.
Reverse Mortgage Example
Let’s look at an example:
- You own a $500,000 home.
- You own the home outright and no longer have a mortgage.
- You want to take money out of the home through a reverse mortgage.
In this scenario, you’ll typically opt to take out money via a line of credit. You’ll likely be able to take out $275,000 if you’re 70 years old. You can take money out of this line of credit where the repayment is made at some time in the future.
With a reverse mortgage line of credit, there’s no repayment obligation, and these lines of credit cannot be:
A reverse mortgage line of credit can only be cancelled if the borrower doesn’t meet their obligations. During COVID-19, a lot of home equity lines of credit were frozen, leaving a lot of older homeowners unable to access money that could have potentially helped them navigate the pandemic.
Scenarios Where a Reverse Mortgage Makes Sense
A lot of people choose to do a reverse mortgage when they’re in retirement and still have a mortgage payment to make. The mortgage payment causes a cash flow problem, which causes a lot of people to take out a reverse mortgage to free up some cash.
Other people want to create a new source of income, while others open a line of credit for when they need long-term care insurance. Need to make a down payment for a continuous care retirement community? A reverse mortgage can help you generate the cash to make this payment.
There are also others that want to downsize, so they’ll use this mortgage to make a second or vacation home purchase.
Using the previous example, let’s say that you a $500,000 home and want to take $200,000 out for the down payment on a continuous care retirement community buy-in with the expectation that you’ll be able to move into the community in two years.
So, in two years, you’re able to move in and take out $200,000 in a reverse mortgage line of credit,
- Closing costs were rolled in.
- Interest accrued for two years.
- Loan balance is $240,000.
If the home is sold for $500,000, you would have net proceeds of $260,000 leftover. The sale of the house pays off the reverse mortgage, which doesn’t require any payments during the two-year period.
Baby Boomers Transitioning Into New Homes
Over a million baby boomers have decided to transition into a new home. The transition may be because the homeowner wants to:
- Avoid having to do maintenance and move into a retirement community.
- Downsize because their home is too big for them now.
A reverse mortgage can also be used in this scenario. The homebuyer can choose to use a reverse mortgage to invest money or to pay for the down payment for the new home. You can also opt to use the reverse mortgage money as a down payment, move into the retirement home and then sell off the other property to repay the reverse mortgage.
There are a lot of options to use the reverse mortgage to make money.
Now, when you’re reaching end of life and pass away, what happens to your heirs? Your heirs will have to pay the loan balance. Traditionally, the home’s appreciation will outpace the reverse mortgage loan balance interest growth.
The heirs would sell the home at the appreciated value and pay off the reverse mortgage.
Let’s assume that over a 10-year period, the home’s value rose $80,000. The loan value will, in most cases, rise less than this amount, allowing the heirs to sell the home with a net profit.
Using a Reverse Mortgage for Cash Flow When You Have Investments
COVID-19 is a prime example of when investors can use a reverse mortgage line of credit when the market’s conditions aren’t optimal. At the start of the pandemic when the markets dipped, a lot of people relied on their reverse mortgage because it’s:
- Doesn’t require the sale of assets
- Made more sense to use at the time
You don’t want to sell when the market is on a dip because you’ll be losing money. Instead, a lot of people used their reverse mortgage to allow the market to rebound before selling off the investments you have.
If you need $500 a month to pay your bills, you can draw from the line of credit much like an annuity.
#1 Misconception About A Reverse Mortgage
If you’re considering a reverse mortgage, the largest misconception is that the bank now owns the home. You still own your home, but the reverse mortgage lender has a lien on the home that allows them to be repaid when the home is sold.
Practices in the 60s through 80s did foster this misconception, but times have changed for the better.
Once you sell the home, you will receive 100% equity you have in the home minus the reverse mortgage repayment. So, once the reverse mortgage is repaid, you or your heirs will receive all of the remaining equity.
Can the Home Be Underwater?
No. The loans are backed by the FHA and insured for the borrowers and their heirs. For example, if a market collapse occurred and your $500,000 home is now worth $200,000 and your reverse mortgage was $300,000, you or your heirs would:
- Sell the home for $200,000
- Repay the $200,000
- Not have to repay the remaining $100,000 balance
Essentially, your heirs would not be inheriting a debt that they cannot afford to repay with a home that has a reverse mortgage.
The heirs nor the estate would have to repay any excess debt beyond the price of the home at the market value at the time of sale of the home.
Steps to Taking Out a Reverse Mortgage
If you’re thinking about a reverse mortgage, you should sit down with a local representative of a reverse mortgage broker who can discuss your goals with you. Local representatives can see where you live and better understand what your needs are.
Local loan officers can run calculations to see if a reverse mortgage is a good option for you.
Counselors will request a meeting with you, which lasts about an hour, and ensures that the loan officer walked you through all of the steps in the mortgage process. If you decide the mortgage is a good option for you, an appraisal is done, and then closing takes about 30 days to complete.
Your money is then available for you to access after closing.
When you meet with a counselor, they do not have an opinion on the mortgage. Instead, the counselor answers all of your questions and provides you with all of the fine details relating to the reverse mortgage. These individuals make sure that you understand a reverse mortgage 100%.
Credit history is considered, but the lender wants to reduce the risk that you’ll go into default rather than make sure you have a high credit score.
A lot of homeowners want to enjoy a better retirement, and a reverse mortgage can help fund this goal. Yes, your heirs will not receive the full value of the home because the mortgage needs to be repaid, but you’ll be able to enjoy a better retirement.
And a lot of children are happy with their parent’s decision to take money out of their home to fund the retirement that they envisioned.
If you want more information about preparing your finances for the future or retirement, check out our complimentary Master Class, ‘3 Steps to Secure Your Retirement’.
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