Over the last decade, reverse mortgages have been aggressively pitched in TV ads as an easy way for seniors to cash in their home equity to pay for living expenses. However, for many, improper use of the product â€“ such as pulling all their cash out at one time â€“ has led to significant financial problems later, including foreclosure.
In actuality, there are some cases where reverse mortgages can be helpful to borrowers. However, itâ€™s essential to do extensive research on these products before you sign. Reverse mortgages are special kinds of home loans that let borrowers convert some of their home equity into cash. They come in three varieties:
- Single-purpose reverse mortgages. Offered by some state and local government agencies and nonprofit organizations, these are aimed at low- and moderate-income borrowers. They are not available everywhere and can be used for only one purpose, such as home repairs, improvements, or property taxes.
- Federally insured reverse mortgages. Known as Home Equity Conversion Mortgages (HECMs), they are backed by theÂ Department of Housing and Urban Development(HUD). This category may be a more expensive borrowing option than traditional home loans with high upfront costs. They tend to be the most widely available reverse mortgage option with no income or medical requirements. They can be used for any purpose.
- Proprietary reverse mortgages. These are private loans backed by the companies that make them.
Who can apply? Homeowners can apply for a reverse mortgage if they are 62 years old, own their home outright, or have a low mortgage balance that can be paid off with the loan proceeds. Qualifying homeowners also must have the financial resources to pay for upkeep, taxes, and insurance and live in the home during the life of the loan.
Consider the following pros and cons as a starting point for trying or bypassing this loan choice. Even though HECM loans require a discussion with a loan counselor, you should bring in your own financial, tax, or estate advisor to help you decide.
Pros of reverse mortgages:
- Theyâ€™re a source of income. Borrowers can select that the amount of the loan be payable in a lump sum or regular payments.
- Proceeds are generally tax-free. Final tax treatment may rely on a variety of personal factors, so check with a tax professional.
- Generally, they donâ€™t impact Social Security or Medicare payments. Again, important to check personal circumstances, but there are usually no penalties relating to members already receiving payments from any program.
- You wonâ€™t owe more than the home is worth. Most reverse mortgages have a â€œnonrecourseâ€ clause, which prevents you or your estate from owing more than the value of your home when the loan becomes due and the home is sold.
- Reverse mortgages may be a smarter option for some downsizing seniors. With proper advice, some borrowers use them to buy new homes.
Cons of reverse mortgages:
- You may outlive your equity. Reverse mortgages are viewed as a â€œlast-resortâ€ loan option and certainly not a singular solution to spending problems. Theyâ€™re recommended generally for older seniors as part of a strategic package of financial solutions to allow them to stay in their homes as long as possible.
- You and your heirs wonâ€™t get to keep your house unless you repay the loan. If your children hope to inherit your home outright, try to find some other funding solution (family loans, other conventional loan products) before you go with a reverse mortgage.
- Application fees can be expensive. Reverse mortgage lenders typically charge an origination fee and higher closing costs than conventional loans. This adds up to several percentage points of your homeâ€™s value.
- Many reverse mortgages are adjustable rate products. Adjustable rates affect the cost of the loan over time.
- If you have to move out for any reason, your loan becomes due. Generally, this is triggered if you or your co-borrower hasnâ€™t lived in the home for a continuous year. So, health issues provide real risk with this product.
The courts have recently put a stop to one of the most onerous problems with reverse mortgages. In October 2013, a Washington, D.C. federal court judge struck down a U.S. Department of Housing and Urban Development (HUD) policy allowing lenders to demand that surviving spouses immediately repay reverse mortgage loans when their spouse dies. Many widows and widowers were forced into foreclosure before this decision.
If youâ€™re considering a reverse mortgage, do some reading. The following agencies offer more extensive pro-and-con information on these products:
- The Consumer Finance Protection Bureau. The CFPB is a U.S. government agency dealing with consumer protection issues in the financial sector.
- The Federal Trade Commission. The FTC is the federal governmentâ€™s major consumer protection agency.
- The Financial Industry Regulatory Authority. FINRA is the largest independent regulator for all securities firms doing business in the United States.
Bottom line: Reverse mortgages have become a popular and controversial loan option for senior homeowners. For some, these products may work well in special situations. However, every applicant should do extensive research and receive individualized financial, estate and tax advice in advance.
Jason Alderman directs Visaâ€™s financial education programs. To follow Practical Money Skills on Twitter:Â www.twitter.com/PracticalMoney
ThisÂ article is intended to provide general information and should not be considered legal, taxÂ or financial advice. It’sÂ always a good idea to consult a legal, taxÂ or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.
Views expressed are the personal views of the author, and do not represent the views of the National Foundation for Credit Counseling, its employees, its members, or its clients.