Reverse mortgages have existed in one form or another since the 1960s, but the modern version is just now beginning to enter public awareness as a viable debt instrument for homeowners. Although this type of loan has sometimes been viewed with distrust by both the financial planning community and the media, demand has been increasing because it can provide a quick solution for cash-strapped retirees. However, despite their usefulness, reverse mortgages are not suitable for everyone, and there are situations where this type of product can be very detrimental. This article will examine the proper use of reverse mortgages and whom they are suited for.
What Is a Reverse Mortgage?
A reverse mortgage allows homeowners to access the equity in their homes without having to make a monthly payment. The proceeds can be paid in either a single lump sum or as a monthly payment. This can obviously be a windfall for clients who need cash to pay medical or other bills. (For more information on reverse mortgages, see The Reverse Mortgage: A Retirement Tool.)
When Is a Reverse Mortgage Appropriate?
Reverse mortgages offer the following advantages for those who qualify.
- Tax-free funds with no restrictions
- Flexible repayment alternatives
- No income qualifications
- No downside risk for the homeowner
Generally, homeowners who can afford to reduce the proceeds from the sale of their homes by the amount of the mortgage are potential candidates, which in many cases will be clients who intend to live in their homes until they die. Clients seeking to reduce their taxable estates may also be interested in this type of loan.
Reverse mortgages may have certain requirements. For example, most reverse mortgages mandate that homeowners must keep their homes in relatively good condition for the duration of their tenure. This may be impossible for those with health or other physical problems, and those who cannot meet this condition will most likely face foreclosure. Paying for upkeep may also be unaffordable for many homeowners, particularly retirees living on fixed incomes. Reverse mortgagees must, therefore, consider this implication carefully and find out exactly what the lender will require of them in the way of maintenance and upkeep.
Homeowners who intend to pass their homes on to their heirs also need to carefully consider the fine print found in many reverse mortgages. Although homeowners themselves cannot owe more than the value of the home, most reverse loan documents stipulate that upon the homeowner's death or cessation of the homeowner's residence in the house, homes with mortgage balances greater than the home's value will be repossessed. The only alternative is for the heirs to produce the balance in cash.
Using the proceeds from a reverse mortgage as a funding source for investments, especially investments that are not guaranteed, is not a good idea. Even investments that pan out must do extremely well over time before they will beat the high fees and adjustable interest rates charged by most reverse mortgages. Finally, low-income borrowers must be aware of the impact that the proceeds of a reverse mortgage may have on their eligibility for public assistance, such as Medicaid. This cannot affect Social Security and Medicare assistance.
Using Reverse Mortgages to Pay for Insurance Coverage
Using the funds from a reverse mortgage to pay for long-term care (LTC) or life insurance can be a much more sensible alternative for borrowers seeking to reduce their liabilities. Granted, this course of action can require careful analysis and forethought, but there are times when a person is relatively certain that they will need LTC and can use a reverse mortgage to pay the cost of premiums that would most likely be unaffordable otherwise. Admittedly, this type of tradeoff can result in the repossession of the home if the homeowner does eventually require care, but this may still be a preferable alternative to forced liquidation of all of the insured's assets (including the home) if a level of care is needed for which there is no coverage.
Homeowners may fund a life policy, even if the mortgage balance exceeds the value of the home at death. A homeowner who purchases a high enough cash value policy with reverse mortgage proceeds that exceed the home's value will still leave his or her heirs in a better position after they have paid the difference than before.
The Bottom Line
Reverse mortgages can provide substantial benefits for the appropriate individual, but prospective borrowers should carefully consider the possible ramifications of this type of loan. Those who wish to learn more about reverse mortgages should consult both their mortgage brokers and their financial advisors for a complete picture of how it can impact their financial well-being.