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 Does a Reverse Mortgage Work?
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.