Here's what homeowners need to consider before taking out a reverse mortgage
Senior housing wealth reached a record $8.05 trillion to close 2020, posting a $234 billion, or 3%, quarter-over-quarter increase, according to recent figures revealed by the National Reverse Mortgage Lenders Association (NRMLA) and data analytics firm RiskSpan.
The NRMLA described the ascent as being primarily driven by an estimated $261 billion, or 2.7%, rise in seniors’ home values. This growth, however, was offset by a $27 billion, or $1.5%, jump in senior-held mortgage debt.
“Reverse mortgages provide a strategic retirement option for older homeowners of all income levels,” Steve Irwin, president of the NRMLA, said in a statement. “Reverse mortgages allow people to pay for in-home care and other services that allow them to age in place or provide an alternative to selling retirement assets after a market downturn. While a reverse mortgage isn’t for everyone, it can provide the financial security that many people are looking for in retirement.”
Despite this record-high increase in equity for seniors’ homes, the popularity of reverse mortgages remains low for older Americans. In 2020, only 42,000 home equity conversion mortgages (HECMs) were sold – dropping by as much as half from 2010, according to data from the US Department of Housing and Urban Development (HUD) obtained by the Center for Retirement Research (CRR) at Boston College.
Citing a 2017 report from the Consumer Financial Protection Bureau (CFPB), the CRR noted that one possible reason for the decline is that reverse mortgages are not in line with the plans many seniors may have for their properties.
“A reverse mortgage reduces the equity homeowners have in their house,” the report said. “Homeowners who wish to sell their homes after taking out a reverse mortgage are particularly at risk because the loan balance is likely to grow faster than their home values will appreciate. This could limit options for moving or handling a financial shock.”
What should homeowners consider before taking out a reverse mortgage?
A reverse mortgage is designed for retirement-age homeowners who have either paid off their mortgage or built a lot of equity in their homes. This type of mortgage is targeted at homeowners who want tap into their home equity to access a fixed monthly payment, line of credit, or a combination of both, without losing ownership of their properties.
Reverse mortgages are often tax-free, and repayments are deferred until the homeowner moves out, sells the home, is unable to pay property taxes or insurance, or passes away. After which, the property is sold, and any excess goes to the owner or their heirs.
There are three types of reverse mortgages, according to the Federal Trade Commission. These are:
1. Single-purpose reverse mortgage
This type of loan is provided by government agencies and non-profit organizations and is the least costly among all reverse mortgage options. It is designed for one purpose that the lender specifies, which may include home repairs and renovations, and property tax payments. Many homeowners with low or moderate income can qualify for a single-purpose reverse mortgage.
2. Proprietary reverse mortgage
Proprietary reverse mortgages are provided by private lenders and do not come with restrictions that are typically attached with single-purpose reverse mortgages. This option is suited for owners of high-value properties who want to access a substantial amount of cash.
3. Home equity conversion mortgage (HECM)
HECMs are federally insured reverse mortgages backed by the HUD and can be used for any purpose. As of last year, the HECM borrowing limit was pegged at $765,600. However, the amount a homeowner can borrow depends on several factors, including the borrowers age, the home’s appraised value, current interest rates, and the borrower’s willingness and ability to pay property taxes and homeowner’s insurance.
Stacy Johnson, founder of Money Talks News, noted that while reverse mortgages are a good way to get extra retirement income, they may not suit everyone. The personal finance expert added that reverse mortgages are not ideal for owners who want to bequeath their homes to their children.
“Remember, the mortgage is getting bigger and bigger,” he said. “When you die, or when you move to a nursing home, someone will have to pay off that mortgage if you want to keep the house in the family… A reverse mortgage is ideal for somebody who needs extra money and doesn’t really care about leaving the house to their heirs.”
Johnson added that while counseling is a requirement for those closing a reverse mortgage – a safety feature built into the law “so seniors don’t get ripped off” - it may be advisable for homeowners to take it before the process even begins.
“My suggestion for anyone thinking about a reverse mortgage is to first get the counseling,” he said. “Ask your questions, understand it, and then you can be more informed and make the right decision.”
What are the alternatives to a reverse mortgage?
In a discussion guide, The CFPB laid down some alternatives for homeowners who may feel that a reverse mortgage is not the right option based on their personal needs and financial situation.
1. Mortgage refinancing
Refinancing with a new, traditional mortgage allows borrowers to lower their monthly payments, especially now with interest rates dropping to historic lows. This option can also enable homeowners to save cash over the life of the loan, helping them build home equity faster.
One potential drawback, however, is that a good credit score (at least 620) is often a requirement for refinancing, and an even higher credit rating (at least 720) is needed to access the best interest rates. Homeowners also need sufficient income to be able of afford the monthly repayments, which can hinder many retirees from taking this route.
2. Tapping into home equity
There are two ways for owners to access home equity – a home equity loan and a home equity line of credit (HELOC).
A home equity loan allows borrowers to access a lump sum against their home’s market value, minus their mortgage balance. This works the same as a traditional fixed-rate mortgage, where homeowners make the necessary repayments – both interest and principal – each month.
A HELOC, meanwhile, lets homeowners borrow and repay, usually a smaller amount, when a need arises. It also gives them the flexibility to reborrow as long as they do not exceed the maximum limit of their available equity. Unlike home equity loans, a HELOC comes with a draw period – often the first part of the term – when borrowers are only required to make interest payments and do not have to pay back the principal.
For owners who are keen on moving to a more affordable home, selling may be a good option. Homeowners can use the money from the sale to fund a smaller house that is easier to maintain.
4. Accessing government-sponsored benefits
Some states offer weatherization programs that allow low-income senior homeowners to stay in their properties through loans, energy improvements, and lower utility bills. Many localities also offer programs to help with property taxes.
5. Waiting for the right time
In some cases, taking a reverse mortgage may not be ideal at the moment. The homeowner may have just reached senior age and plan to stay in the home for much longer. For them, it makes more sense to wait when their personal and financial needs change before considering getting a reverse mortgage.