Over the years, I have written several columns on the subject of reverse mortgages, both to hopefully enlighten people to their purpose and to dispel some incorrect perceptions. With all of the commercials that seem to be airing constantly, I thought it might be time for an update on the subject.
Basically, a reverse mortgage works like a conventional mortgage but in reverse. You are approved for a mortgage amount and may borrow that in a lump sum, as a line of credit to be drawn as needed, in monthly payments for a specified period or monthly payments for life. Interest is charged on the outstanding balance (not the amount approved but the amount you’ve received) and accumulated until either you sell the home, or the last borrower leaves the home, at which time the amount borrowed plus all accumulated interest must be repaid. If the house sells for more than the amount due, the owners or heirs keep the difference. If the house sells for less than the amount due, the Federal Housing Administration (FHA) pays the difference, not the owners or heirs.
There are two changes that have been made recently to protect the financial integrity of the program and the secondary lender — the FHA. First, the amount you can borrow has been reduced such that a person or couple age 62 (all owners have to be at least 62 to get a reverse mortgage) can borrow 42 percent of the appraised value of the home with that percentage gradually increasing with age. Second, borrowers now must show proof (financial statements, tax returns) of their ability to pay homeowners insurance premiums, property taxes and routine maintenance expenses, all of which are required by the lender. This reduces the likelihood of a default that would cost the FHA money as the secondary lender.
Unfortunately, more people than ever are entering retirement with conventional house debt. The days of burning the mortgage (i.e. paying it off) before retiring are becoming less than common, which means that more people are having to make mortgage payments well into retirement. Many of those in this situation didn’t anticipate being in this position and running the risk of exhausting their retirement funds too soon because of this. One solution is to use the proceeds from a reverse mortgage to pay off a conventional mortgage, thus eliminating the need to make monthly payments. While this may impact the degree to which your heirs/children inherit the house, it is a much better scenario than asking your children to support you later in life because you ran out of money.
Reverse mortgages can be helpful, but they are a lifelong debt so explore them carefully before making a commitment. Reverse mortgages are not for everyone. There may very well be much better, more suitable solutions for you to consider before going this route. On the other hand, it could be a good solution for your situation. Do your homework. Proceed with caution and know what you are getting into. As with any financial decision, have the facts straight and make sure that your decision is best for your particular situation. It’s not a one-size-fits-all type decision.
