By: Ashley Camp / ashleyycamp@gmail.com
As the cost of living increases, many retired folks may struggle to cover their costs of living, and since they no longer work and likely have a lower income, traditional loans may not be an option. You may have encountered reverse mortgages if you’re a senior or close to retirement age and have been looking into loan options.
While reverse mortgages are a type of loan, they’re different from other types of traditional loans, so before taking one, it’s essential that you’re aware of what they are and how they work.
What’s a Reverse Mortgage?
Reverse mortgages are a type of loan typically offered to seniors who are sixty-two years old or older. Besides being a senior, you have to have equity in your home. This means that you must have completely paid off your home loan so that you own the property free and clear, or if you are still paying off your mortgage, you must have substantial equity in your home. In most cases, you should at least have 50% equity in your home to qualify for a reverse mortgage.
The amount you may borrow is determined by several factors, including your home’s value, your age, the interest rate, how much equity you have in the property, and the type of reverse mortgage you select.
What sets reverse mortgages apart from conventional loans is how the loan is repaid. Unlike traditional loan types, where the borrower usually has to make repayments soon after borrowing the money, reverse mortgage repayments are handled differently. If you’ve taken a reverse mortgage, the total loan balance must be paid when you die, move into another home like a retirement center, or sell the house.
Reverse mortgages may attract seniors who may not have an income since you typically need an income to qualify for a traditional loan. Also, when applying for a reverse mortgage, your credit score isn’t a factor because the amount you borrow is based on the value of the equity you own in your home.
You may be wondering what will happen should the home’s value decrease because of a drop in the market and the value of the loan increase to more than the value of the property or perhaps, you live longer than expected.
According to federal regulations, the lender is responsible for structuring the loan so that the amount you borrow won’t exceed the property’s value. In this way, the borrower and the borrower’s estate are afforded some protection. They won’t be liable for the difference should the loan amount be higher than the property’s value. Also, the lender should have mortgage insurance to cover this difference.
There are some requirements you must meet if you’re keen on applying for a reverse mortgage which includes the following:
- You must be sixty-two years old or above
- You must live in the home
- You must attend counseling with a government-approved housing counseling agency
- You are responsible for maintaining the house in keeping with the Federal Housing Administration standards
- You have to pay the housing tax, insurance, and utility bills
Once approved, you can choose how you’d like to be paid. You can have it paid in a lump sum, receive a fixed amount every month, or have a line of credit that you withdraw from when you need cash.
Another option is to receive the funds in a combination of ways. For example, you may need a large lump sum to pay for a big expense like a medical bill or a major home repair and, after that, choose to receive smaller monthly payments.
Pros and Cons of Reverse Mortgages
Reverse mortgages may be an excellent option for some, but it’s essential to understand the pros and cons before deciding whether it’s a good option for you.
Pros
- Allows you to access cash from your investment
For many seniors, their home may be their biggest asset, meaning their cash or net worth is tied up in the home. Apart from the difficulty a senior may experience in securing a loan, they may be reluctant to do so because of the risks and commitment involved. If a senior were to secure a loan, they would likely have to start repaying it soon after they receive the funds, and failure to do so will result in default and delinquency.
It may be easier for seniors to borrow money against their home without having to stress over repayments since they will only need to repay the balance when they move out of the house, sell it or die.
- It’s a Non-Recourse Loan which is less risky for the borrower
Because reverse mortgages are non-recourse loans, the lender can’t go after more than what was agreed to as collateral, which is your home. Even if the housing market or interest rates change, the terms of your reverse mortgage will remain the same.
You can stay in the house as long as you want, provided you maintain it and pay your property tax. The loan only becomes payable when you die, move or sell the house.
- You can maintain your lifestyle since you don’t have to move
A lot of people may consider selling their homes and downsizing to convert their liquid assets to cash. If you’re a senior, you don’t have to do this. You can continue living in the house you love while still having access to cash.
Cons
- Your Heirs may inherit less
When you die, the balance you owe will need to be paid. Usually, the home will need to be sold, and the funds can be used to pay the debt. This means that instead of your heirs inheriting your property, they will have to sell it to pay the balance you owe.
Also, a home holds sentimental value for many families, so losing it to repay debt may be difficult.
- It can be costly
While you don’t have to pay monthly installments to repay the loan during your lifetime, there are other costs associated with a reverse loan. Apart from the expenses that come with owning a home that you have to continue to pay to qualify for a reverse loan, like insurance, taxes, and Homeowners Association fees, you will also have to pay origination fees at closing and an upfront insurance premium.
If you don’t have the funds to pay for these, you can roll these expenses into your loan balance, but the amount you receive from the reverse mortgage, either as a lump sum or monthly, will be less.
- You risk losing the home if you can’t afford to pay for its upkeep
You’re responsible for the maintenance of the home. The lender can seize the property if you fail to pay property tax, homeowners insurance, and other costs associated with owning a house.
Conclusion
A reverse mortgage is a loan type that lets you use the equity in your property to borrow money. It’s designed for seniors, and unlike a traditional loan, the debt is only due when the borrower dies, sells the home, or moves house.
References
- Consumerfinance: Can anyone take out a reverse mortgage loan?
- Investopedia: How to decide if a reverse mortgage is right for you
- Bankrate: Reverse Mortgage: What it is and How it Works
- Thebalancemoney: How Much Equity Do You Need for a Reverse Mortgage?
- Experian: Is a Reverse Mortgage Right for You?
- Investopedia: Reverse Mortgage: The Pros and Cons
- CNBC: Here’s what you need to know about reverse mortgages
- Forbes: 5 Reverse Mortgage Pros And Cons
- Consumer.ftc.gov: Reverse Mortgages