FINANCIAL LIFE | FALL 2009 EFFECTReverse Mortgages Offer Cash Flow
by Tom RatelleWith the current economic and market downturn, many seniors are experiencing a cash flow shortfall as their investment portfolios decline and lower interest rates reduce their income. In addition, increasing health care costs are making the financial situation for retirees even more difficult.
It may not have occurred to some senior homeowners that one of their most significant assets—the house they live in—is a potential source of cash. Older homeowners who want to access the equity in their home can take the traditional route of selling the property and downsizing or taking out a home equity loan or a new mortgage. A reverse mortgage, which converts home equity into tax-free income, may be another option to address a decline in income or an increase in expenses.
Borrowing against equity
A reverse mortgage is a planning option that enables older homeowners to borrow money against the equity in their home. To qualify for a reverse mortgage the homeowner, spouse, or co-owner must be 62 years old. The amount of cash available from a reverse mortgage is based on the value of the home, the owner(s) age, and the current mortgage interest rates. Homeowners can obtain money from a reverse mortgage in several ways, including a lump sum cash payment, a monthly cash payment, a line of credit, or a combination of these alternatives. The mortgage does not have to be repaid until the house is sold, the homeowner(s) die, or the homeowner(s) move out of the house for more than one year. If the home is left to an heir, the beneficiary can repay the mortgage or take out a traditional mortgage to repay the loan as long as it is repaid within a year.
Types of reverse mortgages
With a reverse mortgage, the lender makes payments to the homeowner rather than the other way around, and the amount owed on the home increases over time rather than decreases. During the life of the loan, the homeowner is not required to make any interest or principal payments. The mortgage interest is added to the principal amount of the mortgage. Over time, the mortgage amount may exceed the value of the home, especially if the home value has declined, or the homeowner(s) take advantage of the reverse mortgage for many years. However, because a reverse mortgage is secured with the property itself, the amount owed on the mortgage cannot exceed the value of the home when it is repaid.
There are three types of reverse mortgages:
- Reverse mortgages that are used for a single purpose such as paying property taxes or making home repairs are frequently offered by state and local governments as well as some nonprofit organizations.
- Federally insured reverse mortgages, which are known as home equity conversion mortgages (HECM), are guaranteed by the U.S. Department of Housing and Urban Development (HUD). The amount that can be borrowed is subject to a current home value limit of $625,500. The home value limit is subject to change each January. Additionally, the homeowner is required to participate in mortgage counseling by a HUD approved counselor.
- Proprietary reverse mortgages are loans issued and backed by private companies that select lenders to provide them. Compared to HECMs, proprietary reverse mortgages may offer a greater loan amount and lower upfront costs; however, their interest rates are much higher than HECMs.
The right tool for the right job
While a reverse mortgage may be an appropriate tool for the right circumstances, it should be approached cautiously and considered after other options have been explored. It can affect needs-based government assistance programs such as Medicaid or Supplemental Security Income if too much cash is advanced at one time and not spent, leaving cash or savings above qualifying levels. The mortgage can become due if the homeowner fails to pay property taxes, homeowner’s insurance premiums, or properly maintain the home. It may also not be a good choice if homeowners want to leave the home to their heirs, as equity can be significantly reduced or eliminated.
The costs associated with a reverse mortgage, such as origination fees, third-party closing costs, mortgage insurance premium, and servicing fees, are generally much higher than a traditional mortgage. Interest rates are also much higher. Costs can vary from lender to lender, so it is important to shop around and compare total annual loan costs. The homeowner should also clearly understand the amount of actual cash available and the remaining home equity at the termination of the loan.
Although a reverse mortgage may provide a good option to increase cash flow, other less expensive options should be considered first. As with all financial decisions, a clear understanding of your situation and how a reverse mortgage might affect other aspects of your financial life is essential to making the right decision.
The information in this article should not be taken as advice as each person’s situation is different. Please consult with a professional regarding your specific circumstances. LarsonAllen Financial, LLC is not a licensed mortgage agency and does not process mortgage loans. Tom Ratelle is not a licensed mortgage broker. This material may not be republished in any format without prior consent.