[Pam Krueger is the founder of "WealthRamp" and co-host of "MoneyTrack" on PBS. The national spokesperson for The Institute for the Fiduciary Standard, she is a featured columnist for Investopedia. The views expressed by columnists are those of the author and do not necessarily reflect the views of Investopedia.]

Millions of retirees are wondering whether they’ll have enough money to last them through life. Many are looking for some way to generate an additional safe stream of income. One likely source is the biggest piggy bank they have: their homes. Home equity is the biggest asset for the vast majority of families in the U.S., many of whom reach retirement house-rich but cash-poor. So it’s no wonder they show interest when someone mentions a reverse mortgage

The mere thought of a reverse mortgage may conjure up mental images of sketchy late-night TV ads featuring aging actors pitching seniors the dream of remaining in their own home with complete financial security forever. That "forever" should be taken literally: It's far easier to get into a reverse mortgage than it is to get out of one. The only way out – unless you suddenly come into money – is to sell your home and pay off the balance, including all the fees and interest. This is such an expensive proposition in most cases that people who investigate the option generally find that they will be left with nothing if they try to get out by selling their home.

And sketchy is not necessarily the wrong impression. The Consumer Financial Protection Bureau (CFPB) just took action against  three reverse mortgage lenders –  American Advisors Group, Reverse Mortgage Solutions, and Aegean Financial – for deceptive advertising, including "claiming that consumers could not lose their homes." Collectively, the three were assessed fines of  $790,000. For more on what can happen, see Beware of These Reverse Mortgage Scams.

Still the prospect of financing retirement by drawing on the equity in your home is tempting. And for some people, it works.

Here's What a Reverse Mortgage Can Do  

A reverse mortgage is exactly that: a mortgage that works in reverse. You borrow money against the value of your home (the "mortgage" part), but in this case you don't make monthly payments to gradually shrink the loan balance. Instead, the mortgage balance grows as interest is added onto the money you borrowed (the "reverse" part). The lender is paid back by selling your home after you've passed away.

All homeowners age 62 or over whose home is either paid off or "paid down a considerable amount" (in the words of the U.S. Department of Housing and Urban Development website) can consider a reverse mortgage if the home is their principal residence

Who Sells Reverse Mortgages?

You may not be familiar with the companies that offer reverse mortgages; they tend to be finance companies and small banks that specialize in mortgage lending. Some of the country's biggest banks, including Wells Fargo, are now out of the reverse mortgage business, and names like Quicken Loans, American Advisors Group and Home Point Financial (although I am not advocating for any of these options) are the go-to firms. 

And it's no wonder a reverse mortgage sounds like the ideal answer to any retiree's cash flow issues. Imagine: You get to stay in your own home and live out your life on your own terms. Plus, unlike a Home Equity Line of Credit, a reverse mortgage can't be reduced, canceled or frozen.  

There are more government protections in place now for reverse mortgages than there were just a few years ago. Most are FHA-insured under the Home Equity Conversion Mortgage (HECM) program, but not all are. FHA-insured loans carry one key benefit: If the balance left on the loan is more than what your home sells for, you or your heirs don't owe the difference. This is vital because if you're leaving your children a reverse mortgage to deal with, the last thing you want to do is saddle them with debt. 

To ensure that you get the safest contract possible, only do business with an FHA-approved lender under the HECM program. The HECM program also enables you to buy a primary residence if you have enough cash on hand to pay the difference between the proceeds of the loan and the sales price, plus the closing costs. You can search the FHA's database here to find approved lenders.    

Here Comes the Bad News... 

Maybe this is starting to sound like the solution to your financial problems in retirement, but here's the big question: How large a legacy do you want to leave for your heirs? A reverse mortgage will take your home out of your estate unless you children can redeem it from the bank.

Also be aware that taking out a reverse mortgage is not free. One of the violations the CFPB cited the lenders for was saying that borrowers would have "no payments."  Borrowers may be getting money, but these mortgages definitely also require payments. For example: 

  • Mortgage insurance premium of 0.5% or 2.5%, depending on how much money you borrow, plus 1.25% of the outstanding balance each year 
  • Third-party charges such as appraisal, title search, survey, inspection, recording, and credit check fees, mortgage taxes, and insurance 
  • Origination fee to process the loan, which can be the greater of $2,500 or 2% of the first $200,000 of the home's value, plus 1% of anything over $200,000, but no more than $6,000 
  • Monthly servicing fee. For loans with a fixed interest rate or with an interest rate that adjusts annually, the fee can be up to $30, and loans that adjust monthly can run $35 per month.
  • Interest, which varies depending on the interest rate you get on the loan
  • Property taxes, home maintenance and property insurance: To keep your reverse mortgage, you are responsible for paying these. 

Pay special attention to this last point: If you can't afford to pay the taxes and insurance on your home and keep it in good repair, a reverse mortgage gives the lender the right to take it away from you.

Another big pitfall is when the person living with you is not a co-signer on the loan, such as your spouse, partner or child. The reverse mortgage must be paid off in full when the mortgage holder (or holders) vacate the home, whether it's because you pass away or because you must move to a nursing home for more than 12 months, which is considered a permanent move.

If the person living with you isn't on the reverse mortgage, he or she will either have to move if you move (or die) – or pay off the loan using funds from another source. Reverse Mortgage: Could Your Widow(er) Lose the House? explains the details.

Five Scenarios When a Reverse Mortgage Could Work for You

The amount you may borrow depends on the age of the youngest person on the loan, the current interest rate and the lesser of either your home's appraised value, the HECM FHA mortgage limit of $625,500 or the sale price of the home. 

This means that if your home is worth more than $625,500, you're better off downsizing. You won't get more than that out of your home and you still have to pay the property taxes and insurance every year. The higher the value of the home, the higher the taxes and insurance will be.

All these conditions make a reverse mortgage a bad fit for many people, but here are five situations where that's not the case:

  1. You didn't save enough for retirement, need to supplement your income and have no other way to get by. 
  1. You have no children – or your children are financially well-off and don't need to inherit your home.  
  1. You are in good health now and are willing to gamble you'll stay that way. 
  1. You’re sure you will live in the home for the rest of your life. 
  1. You've gone through a divorce and need cash to divide the marital housing asset. The spouse remaining in the home could take a reverse mortgage to buy out the other spouse. Another possibility is to sell the marital home: Each ex-spouse can then use some of the proceeds from their half of the home sale, put enough equity into a new home and get a reverse mortgage on it.  

Which Type of Reverse Mortgage?

Reverse mortgages come in various forms, with various types of payment plans. How to Choose a Reverse Mortgage Payment Plan explains the options. Be sure you get the type that fits your life situation the best.

The Bottom Line

Before you do anything, sit down with a fee-only fiduciary advisor and do some modeling using powerful what-if software such as MoneyGuidePro. If the numbers make sense, the next step is to meet with an HECM counselor, which the FHA requires of everyone who is considering a reverse mortgage – another sign of how complicated the process is. You can search the database here to find one in your area.  That counselor will review the options and help you decide if any of them is a good decision for you.

 

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