Yahoo Finance 6 Facts to Know About Reverse Mortgages
With baby boomers aging and retirement portfolios dwindling due to withdrawals and low returns in the stock market, some retirees may consider a reverse mortgage.
Unlike a conventional mortgage where a homeowner pays off the loan's principal and interest to eventually own the home, a reverse mortgage allows the homeowner to cash out some equity via a loan, with the interest accruing against the total equity.
Many boomers are house-rich, cash-poor, making it tantalizing to tap into their home equity for living expenses. Reverse mortgages are available to people at least 62 years old. But financial experts differ on how these products should be used, with some still seeing these as a last-resort option, while others suggesting they can offer flexibility in a way other loan products do not.
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Majority are still used to as a last resort. Traditionally, reverse mortgages are for people who have exhausted their other income streams but are still having trouble making ends meet and want to stay in their homes.
"It makes sense if you need the money and have no other sources to stream it from. You have to take care of No. 1, that's you," said Michael Foguth, founder of Foguth Financial Group in Brighton, Michigan.
Think long term. Mary Spencer, home loan consultant and reverse mortgage specialist at Univest Bank and Trust Co. in Souderton, Pennsylvania, says people need envision their life in the next several years, such as whether they plan to remain in their home indefinitely. They also need to understand the impact of drawing down their home's equity if they take out money and the impact of compounding interest chipping away at equity.
Interest rates and closing costs can be higher. Spencer said closing costs and interest rates are dictated by how much money is being extended upfront, with the lower the rate, the higher the closing costs. She said in her location, a fixed-rate loan with a credit applied to closing costs is around 5.33 percent. Adjustable rates are around 3.25 percent and higher, and because these are Federal Housing Authority loans, they add a 1.25 percent annualized fee to adjustable rate mortgages, she says. Comparatively, based on credit scores, a 30-year fixed rate mortgage runs around 3.66 percent and a home equity line of credit around 4.75 percent.
You don't get 100 percent of your home's value. Dale Wright, wealth manager at Equity Concepts in Henrico, Virginia, says owners need to have at least 50 percent equity in their homes. "There has to be something for that interest to accrue against," he says.
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Reverse mortgages are age-driven, so the older the person, the more equity he or she receives. Spencer gave rough example: a 76-year-old person living in southeastern Pennsylvania, who owns a $300,000 home outright with no other liens against it, can get about 62 percent of the home's equity, not including closing costs. A 62-year-old homeowner with the same variables can get 52 percent, she says.
You can pay it back -- or not. What makes a reverse mortgage appealing is it doesn't have to be paid back, which is why many homeowners use them as a last resort for income. The loans are paid off when the homeowner leaves -- whether to a new residence or due to death. They are nonrecourse loans, so even if the home value drops, neither the homeowner nor the estate is responsible for the difference. If there is any equity left after the loan is settled it goes to the homeowner or estate. Reverse mortgage funds can be used for many reasons -- daily living expenses, paying a grandchild's tuition, credit card or medical debt or other uses.
Reverse mortgages can be used to fund the purchase of a new primary home, Wright says. For example, a homeowner can buy a $300,000 home, put down 50 percent equity and receive the other 50 percent equity in a reverse mortgage.
David Peskin, president of Reverse Mortgage Funding in Melville, New York, says reverse mortgages can also be used as an alternative to a home equity line of credit because the homeowner has the option to repay the loan.
"They can put the equity back in their home. It's no different than if you went to the bank and got a traditional line of credit. ... With a traditional line of credit I have to pay it back, but with a reverse mortgage line of credit, I can pay $200, $50 or zero. It's a huge advantage for people over age of 62 (since) their cash flow may change on a monthly basis," Peskin said.
Some wealthier retirees are using reverse mortgages for income rather than tapping investments. Peskin says by not tapping investments for extra income, retirees to avoid paying capital gains and allow retirement assets to grow.
However, not all financial advisors think that's the best use of a reverse mortgage.
"Some people do recommend it, saying you're not using equity, interest rates are low and I can get better in the stock market. I'm a believer that you don't take it unless you're going to need it for your day-to-day lifestyle," Foguth says.
Think carefully. People who want to pass their homes to heirs may not have that option, unless the heirs can afford to pay off the reverse mortgage, says Margaret Paddock, Twin Cities market leader for The Private Client Reserve of U.S. Bank in Minneapolis.
"You would not be able to leave that equity to family members or your estate. That would be used by you, instead of the opportunity ... to leave it as a legacy," Paddock says.
Although many homeowners seek reverse mortgages so they can afford to stay in their homes or community, Ash Toumayants, founder of Strong Tower Associates, in Lewisburg, Pennsylvania, says selling and buying a less-expensive place might be a better option.
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"Even if you do the reverse mortgage, you still need to pay property taxes and you must maintain the property, otherwise (the bank) can take the house," Toumayants says. "You can't get a home equity loan for a kitchen, that's over because most of the time there's not enough money. Those are big concerns. It eliminates flexibility and choice, so you can't, say go live with the kids (and keep your equity). It's a privilege to have choice and flexibility. That's what being wealthy means."
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