Reverse Mortgages: The Other Home Loan

  1. Introduction
  2. Taking Stock of Your Finances
  3. Structuring Your Assets
  4. Understanding Required Minimum Distributions
  5. Should You Pay Down Your Mortgage Early?
  6. Reverse Mortgages: The Other Home Loan
  7. Navigating the Medicare Maze
  8. Too Late for Long-Term Care Insurance?
  9. Cutting Your Tax Bill
  10. The Bottom Line

The last chapter discussed the risk of prepaying your mortgage, only to thin out the nest egg you’re counting on in retirement. But what if you’ve already paid down most or all of your loan and find yourself in a financial pinch? With a reverse mortgage, you can actually turn your home in a source of income without having to put it up for sale. But before heading down this road, it’s important to understand what you’re getting into.

How Reverse Mortgages Work

Reverse mortgages convert a portion of the equity in your home into a lump-sum loan, a series of payments, a line of credit that you can tap into as needed or some combination. To qualify, you have to be at least 62 years of age and use the property as your primary residence. In addition, you either have to own the home outright or owe relatively little on your traditional “forward” mortgage. 

Most reverse mortgages are insured by the Federal Housing Administration, which has its own name for these loans: home equity conversion mortgages (HECMs). However, some states offer their own version of this product. In addition, a number of private lenders have their own non-government-insured reverse mortgages. 

In each case, these loans work in a similar fashion. You keep the title to the home when the lender grants the mortgage. But when you die or sell the property, you have to pay the lender the principal plus any interest that has accrued on the loan (in some cases, a spouse can stay in the home after your death). 

The Downsides

The big downside, of course, is that this significantly cuts into the owner’s equity when you or your family members eventually sell your property. Borrowing early on in retirement can be particularly dangerous, as you won’t be able to net as much profit from a home sale when your financial needs increase. At some point, many seniors need the added care that an assisted living or skilled nursing facility provides, and these facilities don’t come cheap.

It’s also important to realize that these loans can be more expensive than they initially appear. On top of the interest that you or your estate will pay upon selling the home, reverse mortgages also come with a number of other fees. HECMs, for example, carry:

  • Mortgage insurance premiums (MIP). With an FHA loan, the government reimburses the lender if the home sells for less than the loan amount.  To cover that expense, it charges two insurance premiums. There’s an upfront MIP equal to either 0.5% or 2.5% of the home’s [appraised] value, depending on how much you borrow in year one. In addition, you’re assessed an annual premium that comes to 1.25% of your loan balance. 
  • An origination fee. Lenders are permitted to charge you $2,500 or 2% of the first $200,000 of the property’s value plus 1% on any amount beyond that, whichever is greater. The most they can assess for a loan origination fee is $6,000.
  • Closing costs. These cover things like the appraisaltitle insurance and the fee for an inspection. There’s no cap on these charges, so it’s worth shopping around and asking what costs the lender passes along to the borrower. 
  • Servicing fees. That’s right – the lender can charge you each month for mailing out account statements and sending you a check. According to government guidelines, they’re allowed to charge $30 a month for fixed-rate loans and those with an interest rate that adjusts once a year. They can charge $35 a month for mortgages with interest rates that reset every month. 

Needless to say, those costs can really add up. To avoid unnecessary fees – and keep more of the equity in your home – some experts recommend taking out reverse mortgages in the form of a credit line rather than a lump sum payment. That way, you’re only paying interest and annual insurance premiums on the amount you actually need.  If you can modify your spending habits to avoid a loan altogether, you’re better off yet. For more, see Is a Reverse Mortgage Right for You? and How to Choose a Reverse Mortgage Payment Plan.

Navigating the Medicare Maze