August 31, 2011
Dear Carrie,
I'm 68 and my husband is 73. Like many retired people, the value of our savings has gone down in the last few years. It's coming back, but we'd feel better if we could find other ways to boost our income. We've paid off our house and really want to stay here rather than downsize. What do you think about reverse mortgages? What are the risks?
—A Reader
Dear Reader,
This is a timely question. Reverse mortgages have been in the news this year, for both positive and negative reasons. A new lower-cost loan introduced by the Federal Housing Authority (FHA) has made reverse mortgages accessible to a greater number of seniors—that's the good news. But changes in Department of Housing and Urban Development (HUD) rules, as well as some major lenders dropping out of the reverse mortgage business, have raised concerns and hurdles for borrowers, making a good dose of caution extra important. I'll try to put both the pluses and minuses in perspective.
The advantages
A reverse mortgage, also called a Home Equity Conversion Mortgage (HECM), is a loan that uses your home as collateral, but instead of making payments to a lender, the lender pays you. And as long as you live there, you're not obligated to pay it back. You (and your spouse) must be 62 or older and have paid off your home (or have a very low mortgage balance that can be paid off at closing with the loan proceeds). No credit check or income verification is required.
The amount you can borrow depends on a number of factors, including your age, the amount of your home equity and current interest rates. Once you have the loan, you can take the cash in a lump sum, monthly payments, a standby line of credit or a combination of all three—and use the money however you wish.
So you and your husband could use the proceeds to augment your monthly income and the loan wouldn't have to be repaid until the house is no longer your primary residence—if you move or pass away. Plus, the borrower never has to pay back more than the value of the home at the time of sale, even if the loan balance is more.
The drawbacks
So far so good, right? Not totally. There are several drawbacks, one of the major ones being cost. As part of the process, you'll pay loan origination fees, appraisal fees and a hefty upfront mortgage insurance fee of two percent of the value of your home (on a $400,000 home that's $8,000!), making this an expensive proposition. To counter this concern, last fall the FHA introduced a new mortgage product called the HECM Saver loan that significantly reduces upfront costs. The Saver loan doesn't let you borrow as much, but the reduced cost makes it more manageable.
That's one down, but there's more. For one thing, your debt (plus interest) is constantly rising. For another, while you keep title to your home with a reverse mortgage, the bank owns a little bit more of it every day.
You're also still responsible for taxes, homeowner's insurance and upkeep. That may not be a problem now, but if there came a time when you couldn't make these payments or keep your property in good condition, it could be considered a default and the loan would come due. If you couldn't pay off the balance, you'd be at risk of losing your home.
Think about what you want to leave behind
If at some point you decide to sell your home, you (or your estate) must repay the money you received from the reverse mortgage, plus interest and fees. Historically, the rules stated that a borrower or his or her heirs never have to pay back more than the house is worth, even if the loan balance is greater than the value of the house.
However, new HUD rules introduced in 2008 say that while the borrower never has to pay back more than the value of the house, a borrower's heirs—even a spouse that isn't a co-borrower on the loan—must pay the full balance if they want to keep the house. That's regardless of whether the home is worth less than the loan. This is currently being challenged in court but—especially in an environment of dropping home values—make sure you're both on the reverse mortgage so one of you isn't left hanging should something happen to the other. And you may want to give your heirs a heads-up.
There's a lot to consider. Fortunately, a lender is required to put you in touch with a HUD-approved counselor before going ahead with the loan. Ask questions and make sure you understand the issues. While a reverse mortgage may make sense in some circumstances, especially for those who very much want to stay in their home and who have few other options, it's far from risk-free. Proceed carefully.
The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. The strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction and investment strategy for his or her own particular situation. Data contained here is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.(0811-5142)
