If you’re 62 or older and short on cash, you might be considering a reverse mortgage.  But before you jump in and sign the paperwork, it’s important you understand how a reverse mortgage works.

When I was young and just out of college, my parents took out a reverse mortgage on their home.  My dad had suffered a debilitating stroke and my mom suffered from congestive heart failure so neither of them were able to work.  I pitched in where I could but I was young and not making much money myself, so they were basically living off of Social Security and a very small monthly pension.

They had significant credit card debt and the mortgage alone ate up almost half their monthly income. Plus, like many people their age they had to deal with costly medical expenses.  I’m sure you know how quickly

Things had always been tight even when my dad was working full-time, but now that their income was reduced the situation was untenable.  In fact, it was downright desperate.  They were quickly spiraling deeper and deeper into debt and there seemed to be no way out.

One day my brother-in-law read an article about reverse mortgages and we started doing some some research.  We considered the pros and cons of reverse mortgages and decided it was the only solution that would alleviate my parent’s cash flow problems and allow them to stay in the house they loved.

To be clear…I am not recommending you go out and take a reverse mortgage on your home.  There are downsides to reverse mortgages and just because it was mostly good for my parents doesn’t mean the same will be true for you.  Do your due diligence, consider all options available to you, and talk it over with someone you trust before committing to anything.

How Do Reverse Mortgages Work?

With a typical mortgage, you borrow money from a lender and then make monthly payments to pay them back with interest.  As you pay down your loan balance your equity in the home increases.

With a reverse mortgage you’re borrowing money against the equity you already have in the home, so it is kind of like a home equity loan in that way.  The key difference is that you won’t be making any monthly payments.  You generally don’t have to pay it back for as long as you live in your home.  The loan will be repaid when you die, sell the house, or when the home is no longer your primary residence.

Put another way, with a traditional mortgage you use debt to convert your income into equity.  But a reverse mortgage is the opposite.  You use the equity you already have in your home to create income.

That income can be paid out in the form of fixed monthly payments, a single lump sum payment, a line of credit, or some combination of the three.  For example, you might want to take a lump sum to wipe out your credit card debt and then keep a line of credit available in case you need to tap into it.

Before you can apply for a reverse mortgage you’ll need to meet with a counselor from an independent and government-approved housing counseling agency.  The counselor will explain how reverse mortgages work, what they cost, their financial implications, and possible alternatives.

Things to Consider Before Signing On

While a reverse mortgage may seem perfect to cash-strapped seniors who are struggling to pay their bills, there are some important things to consider before moving forward.

• Reverse mortgages are expensive. Lenders usually charge a loan origination fee, a mortgage insurance premium, and other closing costs.  You can roll those expenses into the cost of the loan but keep in mind that the higher the fees the more home equity you’ll be giving up.  Be sure to shop around and compare lenders because interest rates and fees can vary from one to the next.
• The amount you owe on a reverse mortgage increases over time.  Since you’re not making any payments to reduce the loan balance, the amount you owe will continue to increase as interest accrues on the loan.  You could end up owing far more than the amount you actually borrow.  In fact, you could end up owing more than the house is worth.
• A reverse mortgage can leave heirs empty handed.  You’ve probably spent decades paying down your mortgage with the intention of one day leaving it to your children.  But a reverse mortgage slowly eats away at your equity and over time you may end up owing more than the house is worth.  If that happens there will be nothing left for your heirs once the house is sold to repay the loan.
• Make sure there is a nonrecourse clause.  Since the loan balance on a reverse mortgage grows with time it is possible to owe more than the house is worth, particularly if home values drop.  A nonrecourse clause will prevent you or your heirs from owing more than the value of the home when it is sold.
  For example, let’s say the balance of your reverse mortgage loan is $170,000 but the house only sells for $150,000.  With a nonrecourse clause in place you or heirs cannot be held liable for the remaining $20,000.  Nonrecourse clauses are pretty standard, but it is definitely something you want to confirm before signing on the dotted line.
• You’ll still have plenty of home-related expenses.  No matter what your equity situation is, you’ll still retain title on the home.  You’re still responsible for paying property taxes, homeowner’s insurance, association fees, utilities, and other expenses.  If you fail to pay property taxes or maintain condition of the home the loan may become due.
• Make sure BOTH spouses are listed on the deed.  Let’s say you and your husband take out a reverse mortgage and only his name is listed.  When he dies, the loan becomes due and you’d have to pay back the loan in full if you want to stay in the house. As explained in this story from the New York Times, this happens all too often to unsuspecting widows who are then forced out of their homes.
• Beware of shady sales pitches.  A reverse mortgage is a complicated financial transaction and there is no shortage of scammers and shady salesmen ready to take advantage of senior citizens.  They mislead seniors about the true cost of reverse mortgages, or they make it seem like free money and that they can never lose their home.  If you feel uncertain or pressured to complete the deal, walk away and take your business elsewhere.  And consider seeking the advice of a family member or trusted friend.

If you are a senior who is currently house rich and cash poor, a reverse mortgage may be an effective option that will increase your cash flow and improve your quality or life.  But you should carefully consider the reverse mortgage pitfalls above before taking any action.

To be a responsible borrower, you need to be ready to meet your commitments even before you apply for a loan, and you need to have a definite plan from the start!

Two things you should do before you get started include:

• You should pick a mortgage lender.

• You should actually have enough money to pay the principal and interest on the borrowed money. In other words, you need to have enough money to pay your mortgage payment each month.

Some of you may everything planned out, but many of you still aren’t ready to answer the questions that lenders will ask you. Knowing what to expect and what questions are going to be asked, can be a great help when it comes to securing the loan, and you may be surprised at how detailed the questions can get.

Also, there are some questions that you are allowed to skip, and these questions may affect the chances of your loan approval. You definitely want to avoid answering questions that are inappropriate or illegal, and you want to be ready to answer the questions that are legitimate and important.

Your Job or Primary Source of Income

You must have a reliable income!  Point, blank period. This is one of the first things that the lender will ask, and it is important that you have a reliable source of income to pay off the debt. You need to be able to prove that you have a source of reliable income. Some lenders (and some government lending programs such as Rural Development loans, FHA loans, etc.) will require that you have been employed for a certain amount of time, and you will need to be able to prove that to your lender through documentation.

Other Sources of Income

Aside from asking about your employment status, lenders will definitely ask about your salary and income. It may seem a private matter to discuss to a complete stranger, but you should keep in mind that you are getting financial assistance from this stranger. Lenders need to know exactly how much you make so they can judge whether you can meet your financial obligations to them.

You should know that lenders will inquire about other sources of income as well. For example, if you receive money from an investment account, they will want to know.

Your Assets and Liabilities

Another way for lenders to gauge your ability to pay your debt is by asking about your assets. They will also ask about any liabilities or debts that you have, and this information will be used to compute your debt-to-income ratio.

Your debt-to-income ratio is important to lenders because it allows them to see if you will be able to handle more debts. The higher this ratio is, the less able you are to pay off additional financial obligations.

Your Credit Score

Lenders use your credit history to see how you have handled your debts in the past. They are likely to ask questions about your credit score, especially if your credit history shows that you have recent loan inquiries. They use your credit score to determine your reliability when it comes to paying off your debts.

Personal Questions

• Your Race

You may be asked questions about your ethnicity. This is not to discriminate against you or your race, but rather this is a way for the Department of Housing and Development to make sure that lenders are not showing bias to any ethnicity in the course of their work.

• Your Marital Status

Lenders use your marital status whether you are single, married, or divorced to see if you are liable for the debts of another individual.

What They Cannot Ask

• Lenders cannot ask you about your plans to get married. This is especially applicable to women. In the past, lenders discriminated against women who had plans of starting a family soon. This was based on the unfair assumption that the she would quit her job, impeding her ability to repay the loan when she got pregnant.

• Lenders are not allowed to ask you about your health or your medical conditions. The law prohibits discrimination against sick or disabled borrowers.

In Conclusion

If you are planning to apply for a loan, you should remember that you have rights. You do not have to answer if the questions are inappropriate or illegal, but you are required to reply to legitimate questions since they will affect your chances of getting your loan approved.

Are planning to apply for a loan? Are you ready for the questions the lender may ask you? If you have applied for a loan in the past, what were some of the questions that you were asked?