Mortgages for Seniors: Pros and Cons of the Reverse Mortgage
Reverse mortgages are unique in the mortgage world, in that instead of buying equity in a home, you're actually selling it. The reverse mortgage is a loan product that was created specifically for people at or approaching retirement and if you're thinking about retirement, but are uncertain whether you can actually afford to retire, a reverse mortgage might be the way to solve this problem. Reverse mortgages are a type of loan product that aren't well understood, however—there are a lot of myths and half-truths circulating about these mortgages, and if you're thinking about applying for one, it's important to know what you're getting into.
An Entirely Different Kind of Mortgage
A conventional mortgage is one in which the borrower receives money from a lender, for the purpose of purchasing a house, and pays it back over time. The reverse mortgage is exactly the opposite: a home-owner enters into a contract with a lender and receives regular payments in exchange for home equity. If the home-owner dies or moves out of the home, the loan is repaid, either by selling or through other means.
Since this turns the whole loan concept on its head, many factors that are relevant to conventional mortgages don't apply to the reverse mortgage. For example, with conventional mortgages, your income, credit rating, and other factors, determine how much you can afford to borrow, but this isn't always true with the reverse mortgage. In the case of the reverse mortgage, the most important factors are the value of your home and whether you own it outright; in some cases, a home-owner must own 100% of the equity in order to qualify for a reverse mortgage, while for some loans, the home-owner need only own a certain amount of the equity. The reduced requirement for qualifying factors is one of the big advantages of the reverse mortgage. Although proof of income and credit rating are important, they're not the only factors that lenders consider, and the income requirement is typically not as high as it is for a conventional mortgage.
A mortgagee can use the money they receive for any purpose, including paying off their existing mortgage; depending on how much they are eligible to receive, and how much their current mortgage owes, they may or may not receive additional cash after paying the mortgage. The borrower can also choose between different reverse mortgage products—typically between a fixed-rate mortgage in which they receive a cash lump sum, a variable-rate product in which they receive regular payments, or establish a line of credit.
Another important advantage of the reverse mortgage is that a mortgagee will never owe more than the home is worth—a problem that can develop with conventional mortgages when the property market slides. With the reverse mortgage, however, the home-owner or their heirs will not have to pay more than the home's appraised value if it should fall below the amount owed on the mortgage at the time of sale.
Are Reverse Mortgages Really Risky?
For senior home-owners with little or no retirement income, a reverse mortgage can effectively solve this issue, but that doesn't mean they're without problems and risks.
Perhaps the biggest potential risk is the question of what happens if all the equity in the home is used up in your lifetime. There are some costs associated with getting a reverse mortgage, and so this isn't outside the realm of possibility for a home-owner who is caught unaware.
The terms of a reverse mortgage require that the home be maintained in good condition, and that property taxes and insurance payments are kept up—and all of these expenses must be met by the home-owner. If these terms aren't met the home can be foreclosed upon, so it's particularly important that the home-owner ensures they'll have sufficient income to meet these expenses. There are also up-front costs associated with a reverse mortgage, as closing costs and other fees associated with convention mortgages apply here too, and these must also be paid for by the home-owner. In addition, interest and tax must be paid on the money that the home-owner receives.
All of these things can add up to a sizable amount of money, and an unwary home-owner may find that they run out of money long before they anticipated. Since people are on average living longer, it's not at all impossible, and once all the equity is gone, the only way to pay back the loan is selling the house—which means both home and income are gone. This isn't a problem that will apply to everyone, and it really depends on individual circumstances; for example, some people with reverse mortgages choose to sell their homes after a time to move to an assisted living facility, or to live with family. It is, however, important to be aware of the prospect of being forced to sell to satisfy the terms of the contract, and to plan for this possibility in advance.
by Gemma Burnside
Federal Trade Commission. Reverse Mortgages. Accessed December 3, 2014.
National Council on Aging. 8 Myths About Reverse Mortgages. Accessed December 3, 2014.