If you are at least 62 years old and a homeowner, a reverse mortgage allows you to convert a portion of your home equity into cash. A reverse mortgage allows you to take out a loan against the equity in your home that you do not have to repay as long as you continue to live in the same home and do not sell it.
If you want to increase the amount available to fund your retirement but dislike the idea of making for loan payments, then reverse mortgage is the best option. However, there are risks, expenses, and pitfalls to consider.
• A reverse mortgage enables senior homeowners to convert home equity to cash.
• The home serves as collateral, and repayment is only required upon the homeowner's relocation or death.
• Different types of reverse mortgage is optimized for specific purposes or objectives.
There are also numerous options for receiving the funds from the reverse mortgage.
How Reverse Mortgages Work
A lender makes payments to the homeowner based on a percentage of the home's value in a reverse mortgage. When the homeowner dies or vacates the home, one of the following can occur:
The homeowner or heirs can sell the property to repay the mortgage.
The homeowner or heirs can refinance the current mortgage to retain ownership of the home.
The lender may be given permission to sell the property to settle the loan balance.
Although there are numerous types of reverse mortgages including those offered by private lenders, they share the following characteristics:
• Older homeowners receive larger loan amounts than their younger counterparts. More expensive homes qualifies for bigger loans.
• The reverse mortgage is set to be the primary lien on the property. Other lenders must repay the primary mortgage holder or agree to subordinate their loans.
• Financing fees may be included in the cost of the loan. • The lender may demand repayment if the borrower fails to maintain the property, keep it insured, pay property taxes, declares bankruptcy, abandons the property, or commits fraud. The lender may also request repayment if the home is condemned or if the homeowner sublets all or part of the property, changes the property's zoning classification, or takes out additional loans against the property.
HECM Loans
Since the 1960s, reverse mortgages have existed, but the most common type is a federally insured home equity conversion mortgage (HECM). These mortgages have been provided by the U.S. Department of Housing and Urban Development since 1989. (HUD).
HECMs are the only reverse mortgages issued by the federal government, which limits borrower costs and ensures lenders will meet their obligations. The principal disadvantage of HECMs is the maximum loan amount cap.
Non-HECM Lending
A variety of lending institutions offer reverse mortgages that are not HECM-related. The primary benefit of these reverse mortgages is that they offer loans with higher limits than the HECM. One disadvantage of non-HECM loans is that they are not insured by the federal government and can be significantly more expensive than HECM loans.
Total Annual Loan Cost on HECM
Although the government sets the interest rate on HECM loans and limits origination fees to 2% of the home's value, the total cost of the loan can vary from lender to lender. In addition, borrowers must consider third-party closing costs, mortgage insurance, and the servicing fee when searching for a lender.
The federal Truth in Lending Act requires mortgage providers to provide borrowers with a cost disclosure in the form of the total annual loan cost to help borrowers compare mortgage costs (TALC). Use this number to compare loans from various lenders; however, keep in mind that the actual costs of a reverse mortgage is actually depend on the income options chosen.
HECMs Provide Several Income Options
The HECM reverse mortgage offers the greatest variety of income-generating options, such as lump-sum payouts, credit lines, monthly cash advances, or a combination of these.
Perhaps the most intriguing aspect of a HECM loan is the credit line, because the amount of money available to the borrower increases as interest accrues. Non-HECM loans provide fewer options for income.
Interest Rates on an HECM
The interest rate on HECMs is tied to the interest rate on a one-year U.S. Treasury security. Borrowers have the option of selecting an annual or monthly variable interest rate.
A yearly variable interest rate fluctuates in proportion to any increase or decrease in the one-year U.S. Treasury security rate. This loan's annual variable interest rate is capped at 2% per year, or 5% over the life of the loan. A monthly adjustable-rate mortgage (ARM) starts with a lower interest rate than a fixed-rate mortgage (FRM) and adjusts monthly. It can fluctuate by 10% over the duration of the loan.
Whether Reverse Mortgages Help Seniors?
The findings of studies examining the impact and utility of reverse mortgages for seniors are mixed.
In a 2019 study that summarized this research, the Brookings Institution noted that a number of studies have indicated that reverse mortgages can provide substantial benefits to borrowers. However, the proportion of households that would benefit from a reverse mortgage is debatable. According to some studies, only 9 percent of seniors would benefit, while others place this number as high as 80 percent. According to the majority of studies, reverse mortgages benefit low-income households the most. This is not only because the money these households receive from a reverse mortgage can be used to cover otherwise catastrophic healthcare costs, but also because there are psychological and health benefits associated with continuing to reside in one's own home.
The same Brookings study contends that the media frequently exaggerates the dangers of reverse mortgage foreclosures. Few local governments initiate foreclosure proceedings against homeowners for nonpayment of property taxes. In the years leading up to 2019, approximately 18% of reverse mortgages were foreclosed, but 75% of these were because the homeowners had abandoned the property. The remaining 25% was due to unpaid property taxes by the homeowners. Because foreclosures are expensive, lenders frequently have an incentive to work with homeowners to resolve nonpayment of taxes.
In a recent study, the Financial Planning Association found that including a reverse mortgage in a retirement portfolio may reduce seniors' exposure to negative market fluctuations. Contrary to expectations, this study discovered that mass affluent Americans, typically defined as those with $100,000 to $1.5 million in investable assets, benefit the most from retirement strategies that using a reverse mortgage is an alternative source of cash flow to a traditional investment portfolio. Instead of using reverse mortgages as a last resort, this research indicates that even wealthy retirees could benefit from one.
Overall, there appears to be a consensus among researchers that there is a gap between the potential benefits of reverse mortgages and their low demand. In other words, many retirees who view reverse mortgages as semi-predatory and risky may actually benefit from them.
Seniors who are contemplating a reverse mortgage is looking as a solution for credit card debt which should evaluate whether the amount of home equity they will lose in reverse mortgage fees and interest is worth the amount of credit card interest they will save. This calculation is complex and should be performed by an accountant or financial planner. A reverse mortgage counsellor may lack the knowledge to respond to this query.
What are the good alternatives to reverse mortgage?
Those who qualify for a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance enjoy much lower fees and competitive interest rates. Seniors can also generate a substantial amount of cash by selling a car they no longer need and by utilizing local transportation programs for the elderly.
Whether borrowers lose their home with reverse mortgage?
Yes. With a reverse mortgage, homeowners can lose their home to foreclosure for a variety of reasons. In the few years leading up to 2019, 18% of reverse mortgages were foreclosed, with 75% of these foreclosures occurring because the homeowners no longer resided in the home and 25% occurring due to the nonpayment of property taxes.
How can I safeguard myself against reverse mortgage fraud?
Due to the complexity of the reverse mortgage process and the prevalence of unfamiliar terms, this scheme is ripe for fraud. The Federal Bureau of Investigation recommends avoiding reverse mortgage scams by ignoring unsolicited advertisements, refusing to sign anything you do not fully comprehend, and seeking out your own reverse mortgage counsellor directly.
The Bottom Line
Taking out a loan against your home is a significant decision that will affect your current finances and your legacy. Loan origination, servicing, and interest are significant costs.
You must also keep in mind that the interest on a reverse mortgage loan will cause your debt to grow over time. If you change your mind about the loan or need to vacate the property for health reasons, the reverse mortgage is paid off with the proceeds from the sale of the property. Depending on the size of the loan and the property's value, there may be little or no money left over after the loan has been repaid.
Before obtaining a reverse mortgage, you should conduct extensive research on the subject, compare costs from multiple lenders, and read all disclosure documents. While it is generally not advisable to invest the proceeds from a reverse mortgage due to the need to recoup the loan costs and interest. Income from the reverse mortgage is a good opportunity to refocus other elements of your investment portfolio. Before assuming the mortgage, you should consider the reverse mortgage's cash flow and the impact this new source of income will have on your overall investment strategy.
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