Helene, a soon to be single retiree, lamented the other day that she wished she had saved more. She didn’t have a pension and she was delaying claiming Social Security because she had longevity in her genes. She felt she was going to have to sell her condo (on which she still had about a $200,000 mortgage) in order to reduce her monthly expenses and still live comfortably in a smaller condo.
I said, hold on, let’s see if a reverse mortgage can help provide for a secure retirement. A few years ago the federal government reformed the reverse mortgage program (technically the Federal Housing Authority’s Home Equity Conversion Mortgage (HECM)) to address many of its unsavory aspects. Most reverse mortgages (nearly 90%) are through the FHA’s HECM program.
Reverse mortgages may be appropriate for those who plan to age in place and don’t plan on leaving a specific amount in their estate to their heirs. Singles like Helene without sufficient savings may find them useful. The big caution, however, is that if she were to sell her condo after using a reverse mortgage her proceeds will be much lower than if had kept paying the traditional mortgage. So there is a pretty big downside to selling your condo before you pass.
Basics of a Reverse Mortgage
A reverse mortgage is a loan but you won’t repay any of it while you live in your home. You are borrowing against the equity in your home. You can get a lump sum amount, a line of credit which you can draw on periodically, or monthly cash payments.
However, unlike traditional mortgages, you do not have to repay the borrowed money. Rather the borrowed amount accumulates interest while you are in the home. Thus, the reverse mortgage gets bigger the longer you are in your home. In other words, the bank owns more of your home the longer you live. This is the “reverse” part of the mortgage, which traditionally decreases as you repay it.
When the home is sold, presumably after the owner’s death, the estate has to repay the reverse mortgage. The outstanding reverse mortgage amount equals the initial borrowed amount plus the monthly interest charge plus a monthly insurance premium.
Even if the outstanding amount exceeds the value of home, the estate will not be on the hook for the shortfall. The monthly insurance premium charge is added to the borrowed amount to guard against negative equity in the home (or having the home being under water) once it is sold.
So this monthly insurance payment makes reverse mortgages very expensive if you sell your home and use the proceeds for another home or another purpose. Your proceeds will be lower by the total of the monthly insurance premium charge. If you sell while you are living, you ended up paying a monthly premium for insurance that you didn’t need. Thus, my key advice is to consider a reverse mortgage only if your estate will be selling the home and not you!
Types of Draws in a Reverse Mortgage
There are two main types of ways to receive reverse mortgage cash – either a line of credit or a lump sum. Most borrowers use a line of credit. You can draw on the reverse mortgage line of credit periodically when you need cash. Interest (and the insurance premium) will only accumulate on the borrowed amount (if any).
A lump sum, however, may be appropriate if you want to pay off your mortgage and eliminate your monthly mortgage payment. A reverse mortgage will always be in the primary position. So you can’t have a traditional mortgage and a reverse mortgage. The reverse mortgage must be used to pay off the outstanding traditional mortgage. You can also use a reverse mortgage to purchase a new home if you downsize.
A third possibility is to have payments made each month (e.g., such as $1,000/month). This draw may be appropriate if the house is repaid but you need supplemental income.
The primary borrower must be 62 years or older. If the home is jointly owned, only one of the borrowers has to be age 62 or older. The borrower must also show that he/she can keep up with property tax and insurance payments on the home.
Maximum Reverse Mortgage Amount
The amount of the loan depends upon your age and the age of your co-borrower. The older you are, the more you can get up to the appraised value of the home or $625,500 (which ever is lower).
This calculator gives can give different scenarios based on your age, any outstanding mortgage, and the home’s value: http://www.reversemortgage.org/About/ReverseMortgageCalculator.aspx
And like any mortgage you will pay closing costs when you obtain a reverse mortgage. Closing costs are more than a traditional mortgage because a mortgage insurance payment is made based on the amount of the loan. These closing costs often are withdrawn from the cash you receive at closing.
Back to Helene
Helene is 66 and she is considering the reverse mortgage. She would use it to pay off her existing mortgage loan and to acquire a small line of credit. Her big issue was whether to stay in her condo. She liked it but wasn’t sure that was her final place. We are meeting later this year to determine how to proceed.