Maybe it’s just me, but it seems as though lately there has been a steady increase in the number of advertisements pushing the benefits of so called “reverse mortgages". In an age where homeownership seems daunting enough, many are wondering what this mortgage product is and whether it could potentially be right for them. The answer lies in understanding what a reverse mortgage is and how it will impact you.
At its simplest level, a reverse mortgage is essentially a way to extract equity from your home. The money can be used for any number of things, including financing home improvements, paying off your current mortgage, supplementing your retirement income, or paying for healthcare expenses. Sound kind of like a home equity line of credit (HELOC)? Well, in a way it is, and it isn’t.
The reverse mortgage is a rather unique beast, and there are a couple of important items that you should understand. First off, an individual has to be 62 year of age or older to take advantage of a reverse mortgage in the United States. Also, a reverse mortgage may only be taken out on an individual’s primary residence. The most important unique factor about reverse mortgages, however, is that they do not require a homeowner to pay back the loan for as long as he or she lives in the home. Unlike a traditional mortgage or line of credit that requires monthly payments, reverse mortgages do not get paid off until (1) you die, (2) you sell your home, or (3) the home is no longer your primary residence. An additionally nice feature about these loans is that any advances obtained through a reverse mortgage are not taxable, and generally don’t affect one’s Social Security or Medicare benefits. These products were plainly designed for our older population to give them access to money that they otherwise might not be able to secure.
The next question you might be asking is how do I receive the equity from my home? Your options are basically two-fold. You can choose either to draw the principal in a lump sum amount, or you may choose to receive monthly payments over a specified term (or some combination of the two).
Regardless of how you choose to receive the money, the next important issue to understand is the financial workings of a reverse mortgage. Although a homeowner is under no obligation to satisfy a reverse mortgage until one of the three conditions set forth above is met, you are nonetheless free to do so without incurring a pre-payment penalty. This is important because a reverse mortgage operates much like a revolving credit line. Any payments you make toward the reverse mortgage increases your available credit by that same amount, while interest accrues on the mortgage balance.
While not critical for our purposes in this article, if you are considering a reverse mortgage, be aware that there are three types offered in the marketplace. The first is the single-purpose reverse mortgage. This product is offered by some state and local government agencies, as well as some nonprofit organizations. Single purpose reverse mortgages tend to be the least expensive of the three options, but they are also unfortunately the most restrictive. Anyone considering this option should be aware that the product’s name is very telling; the loan can only be used for a single purpose that must be identified to the state or local agency lending the money.
The second is the federally-insured reverse mortgage, also known as a Home Equity Conversion Mortgage (HECM). These products are backed by the Department of Housing and Urban Development (HUD). Unlike a single purpose reverse mortgage, a HECM can be used for any purpose, but that comes with a catch. These products may be more expensive than traditional home loans, and the upfront costs are often high.
The final option is the proprietary reverse mortgage. These are essentially private loans backed by the companies that developed them. Except for being backed by HUD, these products generally carry the same features and risks associated with HECMs.
While a reverse mortgage may not be right for everyone, the product can be extraordinarily beneficial when matched with the right homeowner. These loans allow our older population to extract equity from their real estate for funding which they might not otherwise be able to secure elsewhere. If you are considering one, I would only recommend that you do your homework, know your rights and that get the best deal that you can.