Special Situations: Live Within Your Means: Cash From a Reverse Mortgage

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This is activity 25 of 35 in the Special Situations in Prosperity Quadrant IV trek.

The activity: Consider the advantages and disadvantages of a reverse mortgage.
The trek: Improve cash flow and use net worth to supplement income.
The terrain: Prosperity Quadrant IV (negative cash flow; positive net worth).
This activity suitable for: Families exploring options for cash to reduce debt.
Difficulty rating: Moderate

What is a Reverse Mortgage?

From the AARP websiteA reverse mortgage is a special type of home loan that lets a homeowner convert a portion of the equity in his or her home into cash.”

A reverse mortgage is a type of mortgage in which a homeowner can borrow money against the value of his or her home.

A reverse mortgage is an interest-bearing loan secured by the equity in your home.

To be eligible, you and any other co-borrowers, such as your spouse, must own your home and be 62 or older – although some lenders offer reverse mortgages to individuals as young as age 60.

No repayment of the mortgage (principal or interest) is required until the borrower dies or the home is sold. After accounting for the initial mortgage amount, the rate at which interest accrues, the length of the loan and rate of home price appreciation, the transaction is structured so that the loan amount will not exceed the value of the home over the life of the loan.

Often, the lender will require that there can be no other liens against the home. Any existing liens must be paid off with the proceeds of the reverse mortgage.

A reverse mortgage provides income that people can tap into for their retirement.

Caveat: This activity is considered to be a strategy of last resort for finding cash to meet debt and spending obligations.

Getting Equity From a Home: Three Options

Homeowners who want to tap the equity in their homes typically have three options.

  1. They can sell their spending-how-to/housing-costs-how-to/”target=”_self”title=”Housing side trips – selling a home, buying and maintaining a house” >house and downsize
  2. They can take out a home equity loan
  3. They can consider a reverse mortgage.

Like a home equity loan, a reverse mortgage allows you to convert your home equity to cash that you can use for any purpose. Unlike other home loans, however, homeowners make no interest or principal payments during the life of loan. The interest is added to the principal, which is why reverse mortgages are often called “rising debt” loans. Unless you opt for a fixed-term loan, the loan only becomes due when you die, sell your home to move or otherwise leave your home for more than 12 months—for instance, if a health issue requires you to enter a nursing home.

The Advantages of a Reverse Mortgage

The advantage of a reverse mortgage is that the borrower’s credit is not relevant, and is often unchecked, because the borrower does not need to make any payments. Because the home serves as collateral, it must be sold in order to repay the mortgage when the borrower dies (in some cases, the heirs have the option of repaying the mortgage without selling the home).

The reverse mortgage loan is a mortgage against your house which is paid by a lump sum, monthly payments, or a line of credit – usually some combination of these three.

Your qualification for the loan is not dependent on your income or credit rating.

The reverse mortgage does not have to be repaid until you die or move out and you get to remain in your home (keeping the title). The lender cannot come after your other assets such as other properties or investments, the loan only applies to the house.

The Disadvantages of a Reverse Mortgage

These types of mortgages have large origination costs relative to other types of mortgages. These costs become part of the initial loan balance and accrue interest.

These reverse mortgage loans often have very high fees and interest continues to be added over the life of the loan until it is repaid or you die and your estate has to reconcile the debt against your home.From consumerlaw.orgReverse mortgages are high-cost loans. Origination fees and insurance premiums typically eat up $25,000 or more of the total proceeds of a common reverse mortgage on a $250,000 house….Interest charges, which pile up over the life of the loan get added on top of that.”

Senior citizen borrowers with good credit should carefully analyze the options of a more traditional mortgage, such as a home equity loan, against a reverse mortgage.

If you take out a reverse mortgage and then later on decide to move you could be left with less cash than if you had simply sold the home in the first place without acquiring a reverse mortgage.

Also, it’s true that a reverse mortgage allows you to pass the home on to your heirs – but keep in mind that the price tag of the mortgage will still be attached to it. If your heirs wish to keep your home they will need to have enough assets to cover the debt, perhaps leaving your heirs with the likely choice of renting out the home or selling it altogether.

Reverse mortgages are quite expensive. Like traditional mortgages and home equity loans, you will be charged interest, but interest rates for reverse mortgages are generally higher than these other types of loans. In addition, the fees and costs associated with reverse mortgages are often significantly higher, too – sometimes as high as 4-8 percent of the total loan amount. You can usually have these costs deducted from the loan amount, instead of paying for them out of pocket, but either way, you may end up with less cash than you expected.

Also, be aware that reverse mortgages must be the primary mortgage on your home, so if you have another mortgage already, you will have to borrow enough to pay that off, too. That may also reduce the amount of cash left for you to use.

You are still the owner of your home and therefore responsible for property taxes, insurance and home maintenance costs. If you are not able to meet these obligations, the lender may have the right to foreclose on your home, leaving you in the worst possible situation—no place to live, and no more home equity to draw on.

Even if you can keep up these payments, you may get to the point that you want or need to move into a smaller home, or into an assisted living facility, for reasons other than cost. At that point, your loan will come due. With compounded interest due, you may be surprised to find out how much you owe, which may restrict your future housing choices.

Using Your Reverse Mortgage Loan Wisely

Tapping into your home equity in your retirement years through a reverse mortgage is a very serious decision. For many borrowers, choosing a reverse mortgage is a last resort way to secure additional monthly income in retirement. Whether it is the right decision for you may ultimately depend on a number of factors – your health, your spouse’s health, other sources of income, the reason you’re tapping your home equity, when you do it and how wisely you use your loan proceeds. Unfortunately, some financial professionals who profit from selling reverse mortgages aggressively urge homeowners to obtain them even when they are not necessary – and to use the money to take dream vacations, buy a second home or invest in risky or illiquid investments. In some cases, those who sell the mortgages may also profit from the sale of the touted investment, giving them twice the incentive to talk you into a loan you may not need.

When you obtain a reverse mortgage, you normally have several options for receiving the funds. You can take a lump sum payment, set up a line of credit that you can draw on as needed or set up regular periodic payments. Depending on your lender, you may also be able to set up a combination of these options. For example, you may decide to receive a portion of the loan amount in monthly payments, and leave the remainder as a line of credit that you can use for unexpected expenses.

Whichever you choose, make sure you use your loan wisely. Just because you don’t have to pay back it back as long as you live in your home doesn’t mean you should treat it as “mad money.” Reverse mortgages were originally designed as a tool for allowing aging, low-income homeowners to keep their homes by providing a source of additional monthly income to meet expenses. Now, as lenders are realizing that more and more Americans are retiring and sitting on large pools of home equity, they are beginning to aggressively market reverse mortgages to younger retirees as a way to finance a more extravagant retirement lifestyle than they could otherwise afford. The trouble is, those same homeowners may need their home equity some day for something far more pressing than a vacation, only to find that it has already been spent.

Don’t take out a reverse mortgage to buy other financial investments. The fees and interest of the reverse mortgage will likely surpass any profit you may earn from investing. If you are approached by a financial professional to do a reverse mortgage in order to fund a particular investment, keep in mind that all investments carry risk and costs—and the higher the promised return, the higher the risk. It’s best to steer clear of investments that are risky or underdiversifed—as well as those that make it expensive, if not impossible, for you to access your money if unexpected expenses arise.

Tips When Considering Reverse Mortgages

Weigh All Your Options: Whether you need money to pay bills, or just want some extra cash, a reverse mortgage should ideally be a last, not a first, resort. Does it make more sense to sell your house—and either downsize or rent while carefully investing the sale proceeds? Take out a home equity loan or line of credit? Can you consolidate credit card debts? Even if you are having trouble paying for your taxes or for home maintenance, there may be local government assistance programs that can help. Whatever your situation, ask your state agency on aging about less risky, or lower cost, ways to address your needs.

Understand the Risks, Costs and Fees: Just because you won’t be making any interest payments as long as you live in your home doesn’t mean the interest rate doesn’t matter. If you do decide to move, for whatever reason, you will have to pay back the loan plus compounded interest. The same is true if you have to leave your home, for whatever reason, for more than 12 months. Be sure to ask about all costs and fees, including any prepayment penalties.

Recognize the Full Impact of Your Decision: While you typically do not have to pay taxes on the proceeds of a reverse mortgage, the income or lump sum you receive could impact your eligibility—or your spouse’s eligibility—for various state and federal benefits, including Medicaid. In addition, depending on the laws of your state, a reverse mortgage may not enjoy the same home-equity protection that would otherwise apply if you have a health emergency and need to enter a nursing home – and your spouse must liquidate assets to pay for that care. Finally, a reverse mortgage is generally not the right choice for those who want to leave their homes to their heirs.

Get Independent Advice: Reverse mortgages are such complicated transactions that the federal government requires borrowers to meet with HUD-approved counselors before obtaining a federally guaranteed loan. (Most loans are federally guaranteed, but increasingly lenders are offering proprietary loans that are not.) Make sure that any counselor recommended by your lender is truly independent by asking whether he or she receives any funding from the lender or the mortgage industry. Even if you are applying for a loan that is not federally guaranteed, it is a good idea to get advice from a trusted financial adviser who has no interest in either the mortgage or any investment you plan to make with the proceeds. In any event, before you agree to a reverse mortgage, be sure to consult with legal and tax professionals who know the consequences of reverse mortgages for residents of your state and who are not connected in any other way to the transaction or the lender.

Seniors obtaining federally insured reverse mortgages are required to undergo a counseling session from a HUD-approved non-profit counseling agency. Every owner on the title to the property must receive this counseling. Non-federally insured lenders generally require this counseling as well (and it’s the law in California). The purpose of the counseling is to ensure you understand the complexities and conse­quences of these loans and your options. Lenders are not supposed to collect any fees or start processing the loan until you have completed this session, obtained your Certificate of Borrower Counseling, and presented this to them.

In April of 2008 the Department of Housing and Urban Development (HUD) issued new rules that allow borrowers to be charged for the counseling session. This was previously not allowed. The counseling fee should be reasonable for the service provided and not exceed $125. Further, the counseling fee can be paid directly by the consumer (or related parties), by the lender, or paid out of the loan proceeds.

Approved counseling agencies may be found at http://www.hud.gov/offices/hsg/sfh/hecm/hecmlist.cfm or by calling HUD’s interactive referral line at 800-569-4287. Lenders are not supposed to steer you to a particular counseling agency.

Be Skeptical of Reverse Mortgages as Part of an Investment Strategy: If someone urges you to obtain a reverse mortgage to make an investment or purchase an insurance product or a security, such as a deferred annuity, be very skeptical, particularly if they are promising high returns. In essence, they are encouraging you to speculate with your home equity, which you may need for more critical purposes down the road. Also consider what will happen if the returns turn out to be less than promised, or worse, you lose the principal. If you cannot sustain that kind of low return or loss, you should probably not be making the investment with your home equity.

Ask the Right Questions About the Proposed Investment Strategy: Reverse mortgages are an extremely costly way to fund an investment. Before you obtain a reverse mortgage for investment purposes, make sure you understand both the terms of the loan and the terms of the investment. What fees must you pay, directly or indirectly, for the reverse mortgage? What are the costs and fees associated with buying the investment? With selling it? How easy will it be to get your money out if you need it suddenly? Does the investment have a long surrender or lock-up period? What is the potential downside? Is it marketed and sold by the same person or entity that is offering the reverse mortgage? How is the reverse mortgage broker compensated? How is the seller of the investment compensated?

Your Home Equity May Be Your Most Valuable Asset

Home equity is often a homeowner’s most valuable asset, and most precious source of retirement security. Reverse mortgages can be a useful tool for certain older Americans who might otherwise face losing their homes. But for anyone else, they are an expensive option that may prematurely deplete your home equity. Homeowners should consider all the risks and explore all of their options before taking out a reverse mortgage, and even then, should use the loan funds wisely.

How Reverse Mortgages Work

A reverse mortgage is still a loan; however, the lender pays you — in a lump sum, a monthly advance, a line of credit, or a combination of all three — while you continue to live in your home. To qualify for a reverse mortgage, you must own your home. The homeowner is not required to pay back any of the loan advances or interest until the loan term is over. Generally, no repayment is due until the borrower no longer occupies the house. The amount you are eligible to borrow generally is based on your age, the equity in your home, and the interest rate the lender is charging. Funds you receive from a reverse mort­gage may be used for any purpose.

With a reverse mortgage, you retain title to your home. You are responsible for maintaining your home and paying all real estate taxes. Depending on the plan you select, your reverse mortgage becomes due with interest when you move, sell your home, reach the end of a pre-selected loan period, or die. When you die, the lender does not take title to your home, but your heirs must pay off the loan.

Facts to Consider 

Reverse mortgages are rising-debt loans. The interest is added to the principal loan balance each month, because it is not paid on a current basis. The amount you owe increases over time as the interest compounds. Some reverse mortgages have fixed-rate interest; others have adjustable rates that can change over the lifetime of the loan.

Reverse mortgages use up some or all the equity in your home, leaving fewer assets for you and your heirs.

There are three types of reverse mortgages — Federal Housing Administration (FHA)-insured, lender-insured, and uninsured — and these vary according to their costs and terms. Check the features of each to select the type that is best-suited for your needs. FHA-insured products are known by the name of “Home Equity Conversion Mortgage” (HECM). Before considering any reverse mortgage, consult with family members, your attorney, or financial advisor.

Reverse mortgages typically charge loan-origination fees and closing costs. Insured plans charge insurance premiums, while some plans have mortgage servicing fees. You may be able to finance these costs if you want to avoid paying them in cash. But, if you finance the costs, they will be added to your loan amount and you will pay interest on them.

Your legal obligation to repay the loan is limited by the value of your home at the time the loan is repaid. This could include any appreciation in the value of your home after your loan begins.

There are various reverse mortgage plans offered today. Consult your attorney or financial advi­sor about the tax consequences of the particular plan you are considering.

Reverse Mortgage Safeguards

The federal Truth in Lending Act (TILA) is one of the best protections you have with a reverse mortgage. TILA requires lenders to disclose the costs and terms of reverse mortgages. This includes the Annual Per­centage Rate (APR) and payment terms. If you choose a credit line as your loan advance, lenders also must tell you about charges related to opening and using your credit account.

Before signing any contracts for a reverse mortgage, be sure to check on the reliability of the company with the BBB at http://www.bbb.org/. The BBB also provides complaint and dispute resolution assistance for consum­ers to seek recourse and achieve a fair settlement if they have been treated unfairly in the lending process.

You should also be aware that California law requires that you be given a translation of your contract, and every term in it, before you sign it, if the business negotiated with you primarily in Spanish, Chinese, Tagalog, Vietnamese, or Korean.

Using a Reverse Mortgage to Prevent Foreclosure

If you are facing foreclosure or bankruptcy, a reverse mortgage may be an option to enable you to stay in your home. Contact a local HUD-approved counseling agency to discuss all your options. Be prepared to discuss recent correspondence from your lender and any other information relevant to your situation. Again, you should also consult with family members, your attorney, or financial advisor.

The Three Types of Reverse Mortgages

There are 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.

The HECM lets you choose among several payment options. You can select:

  • a “term” option – fixed monthly cash advances for a specific time.
  • a “tenure” option – fixed monthly cash advances for as long as you live in your home.
  • a line of credit that lets you draw down the loan proceeds at any time in amounts you choose until you have used up the line of credit.
  • a combination of monthly payments and a line of credit.

You can change your payment option any time for about $20.

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.

Reverse Mortgage Loan Features

Reverse mortgage loan advances are not taxable, and generally don’t affect your Social Security or Medicare benefits. You retain the title to your home, and you don’t have to make monthly repayments. The loan must be repaid when the last surviving borrower dies, sells the home, or no longer lives in the home as a principal residence.

In the HECM program, a borrower can live in a nursing home or other medical facility for up to 12 consecutive months before the loan must be repaid.

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.

How to Shop for a Reverse Mortgage

If you’re considering a reverse mortgage, shop around. Compare your options and the terms various lenders offer. Learn as much as you can about reverse mortgages before you talk to a counselor or lender. That can help inform the questions you ask that could lead to a better deal.

  • If you want to make a home repair or improvement – or you need help paying your property taxes – find out if you qualify for any low-cost single-purpose loans in your area. Area Agencies on Aging (AAAs) generally know about these programs. To find the nearest agency, visit www.eldercare.gov or call 1-800-677-1116. Ask about “loan or grant programs for home repairs or improvements,” or “property tax deferral” or “property tax postponement” programs, and how to apply.
  • All HECM lenders must follow HUD rules. And while the mortgage insurance premium is the same from lender to lender, most loan costs, including the origination fee, interest rate, closing costs, and servicing fees vary among lenders.
  • If you live in a higher-valued home, you may be able to borrow more with a proprietary reverse mortgage, but the more you borrow, the higher your costs. The best way to see key differences between a HECM and a proprietary loan is to do a side-by-side comparison of costs and benefits. Many HECM counselors and lenders can give you this important information.
  • No matter what type of reverse mortgage you’re considering, understand all the conditions that could make the loan due and payable. Ask a counselor or lender to explain the Total Annual Loan Cost (TALC) rates: they show the projected annual average cost of a reverse mortgage, including all the itemized costs.

Be Wary of Sales Pitches

Some sellers may offer you goods or services, like home improvement services, and then suggest that a reverse mortgage would be an easy way to pay for them. If you decide you need what’s being offered, shop around before deciding on any particular seller. Keep in mind that the total cost of the product or service is the price the seller quotes plus the costs – and fees – tied to getting the reverse mortgage.

Some who offer reverse mortgages may pressure you to buy other financial products, like an annuity or long term care insurance. Resist that pressure. You don’t have to buy any products or services to get a reverse mortgage (except to maintain the adequate homeowners or hazard insurance that HUD and other lenders require). In fact, in some situations, it’s illegal to require you to buy other products to get a reverse mortgage.

The bottom line: If you don’t understand the cost or features of a reverse mortgage or any other product offered to you – or if there is pressure or urgency to complete the deal – walk away and take your business elsewhere. Consider seeking the advice of a family member, friend, or someone else you trust.

Your Right to Cancel

With most reverse mortgages, you have at least three business days after closing to cancel the deal for any reason, without penalty. To cancel, you must notify the lender in writing. Send your letter by certified mail, and ask for a return receipt. That will allow you to document what the lender received and when. Keep copies of your correspondence and any enclosures. After you cancel, the lender has 20 days to return any money you’ve paid up to then for the financing.

Reporting Possible Fraud

If you suspect that someone involved in the transaction may be violating the law, let the counselor, lender, or loan servicer know. Then, file a complaint with:

Whether a reverse mortgage is right for you is a big question. Consider all your options. You may qualify for less costly alternatives. The following organizations have more information:

Resources

For more information about reverse mortgages, contact the Home Equity Information Center of the Ameri­can Association of Retired Persons (AARP), 601 E Street, NW, Washington, DC 20049 or go to http://www.aarp.org/money/revmort/.

The National Reverse Mortgage Lenders Association (http://www.nrmla.org/) has developed a Code of Conduct and Best Practices for customer service and consumer protection. They can be contacted by phone at 1-866-264-4466.

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 how to get the best deal.

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.

Reverse Mortgage Education Project
AARP Foundation
601 E Street, NW
Washington, DC 20049
www.aarp.org/revmort
1-800-209-8085

U. S. Department of Housing and Urban Development (HUD)
451 7th Street, SW
Washington, DC 20410
www.hud.gov/offices/hsg/sfh/hecm/rmtopten.cfm
1-800-CALL-FHA (1-800-225-5342)

Federal Trade Commission
Consumer Response Center
600 Pennsylvania Avenue, NW
Washington, DC 20580
www.ftc.gov/bcp/menus/consumer/credit.shtm — Click on “Mortgages & Your Home”
1-877-FTC-HELP (­1-877-382-4357)

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