The Pros and Cons of a Reverse Mortgage

Over the years a number of investors have utilized the tool of a reverse mortgage as a means to provide additional income in retirement. While generally speaking a reverse mortgage is not something one should aspire to attain, it is not the poorest of solutions that it once was. In recent years there have been a number of new regulations pertaining to the reverse mortgage market place that have greatly altered the cost to the consumer. However, as a trade off to these new regulations they have become far less profitable and a large number of banking institutions no longer offer them.

What is a reverse mortgage (RM)…The concept is a fairly simple one. When you apply for a loan through a bank in a traditional 30 year mortgage, the payments are amortized with principal and interest over the duration of the loan. In a RM, it is precisely the opposite. Rather than making monthly payments, the homeowner will receive monthly payment on a similar payment schedule. Each month the payment is added to a lien on the home in a mortgage that is comprised of principal and interest. The first concept that is often misunderstood is that you are NOT selling your home. Rather simply accumulating debt against the equity in the home. At any point should you opt to actually sell your home in the future, you must pay off the outstanding loan no different than if you sold your home with a traditional mortgage. The remaining equity is still yours.

One important benefit of a RM is that this is a non-recourse loan guaranteed by the Federal Gov’t. A non-recourse loan means that the lender has only your property as security for their loan…they have no other way to obtain repayment of the principal and interest. This means that should you borrow the maximum allowable amount and receive payments over 30 years, and eventually accumulate more debt than the home is worth, neither you nor your heirs can be liable for the debt. The bank must let you stay in your home liability free. There is no obligation to satisfy the debt while you reside in the home. Essentially, the bank makes an assumption that over a long enough period of time, the value of your home will grow faster than the outstanding loan balance making the loan profitable to the financial institution.

What is the maximum amount you can borrow…As of 2012 the maximum loan amount in a RM is based on a value of $625,500.00. Your house must be appraised at enough to achieve this in a loan. Additionally if your home is valued at 2 million dollars, you may still not exceed the maximum loan value. These values have been adjusted upwards in recent years.

How do you get paid…There are several forms of payment with a RM. The most common is the monthly payment. This is the reverse amortized loan amount. You also have the option to utilize a lump sum payment, and the interest rate charges are more favorable with that option.

What if you have an outstanding mortgage on the property already…It is possible depending on the size of the loan to still qualify for a reverse mortgage for individuals with an outstanding mortgage payment. If there is sufficient equity in the home you may be able to utilize the payment from the reverse mortgage to satisfy all or some of the primary mortgage payments due.

What are the interest rates…The rates at one time where one of the major obstacles for those in need of the income. They were substantially higher than a traditional 30 year mortgage. That is no longer the case with some of the new regulation in place. The rates are now comparable to a traditional mortgage. Additionally the closing costs that were once dramatically higher than a traditional mortgage have become much less expensive and can be compared to a traditional loan. It should be noted that typically if you opt for a lump sum payment the interest charges are fixed but the monthly payment is typically set to a variable rate.

What about your credit…Since the loan is secured by the equity in your home only, there is no credit requirement. The only concern the lender has is the appraised value of the home and any other outstanding liens on the property. In addition the payments will not have any impact on your Social Security or Medicare payments.

Why not utilize this option…As stated earlier this is not a solution one should aspire to achieve. Should you have no need for additional income this would likely be a foolish option. That debt accumulated will be eventually levied against the home. So if you are concerned with maximizing assets left to your heirs, this can have a negative effect. If you plan to move and sell the home you would not likely want to pursue this either. Once the home is sold, before you can pull the equity you must satisfy the lien. If you live in the home only a few short years after taking the maximum RM amount, you may have compounded the loan at a rate of 5% while seeing your home value decline from the original appraisal hence leaving you less equity than originally planned for.

Who should take a RM…The answer to that is anyone whom truly wants to stay in their home for an extended period of time or the remainder of their lifetime, and simply needs the income. Being forced to move in your senior years because you can no longer afford the property taxes can be a traumatic thing if it is not something you want. For the majority of Americans, their home is the single biggest investment you will make in your lifetime. You cannot take it with you when you die. Spending the asset down in retirement is not unlike taking a withdrawal from your IRA. You saved those assets to eventually deplete them. If you truly want to enjoy your retirement in the home that carries memories, it can be a viable option.

Another scenario we sometimes see is that of the newly retired individual who wishes to "snowbird". Perhaps you live in NY and would like a winter condo in Florida. Maybe you can afford the monthly fees but not the price of the condo itself. Should you own your home debt free in NY, you can utilize the payments from the RM on your primary residence to cover the mortgage on the condo in Florida if the loans are of equal value. This would have no likely impact to your estate as while you accumulate debt on one property, you subsequently accumulate equity on the other. The entire time you still have the option to sell either property at any point and make one your permanent residence.

Before utilizing this option, it is a good idea to speak with your estate planning attorney as well. Income from a RM may impact Medicaid eligibility in terms of things such as Long Term Health Care benefits depending on the state you reside in. Also should you wish to retitle your house, it is very difficult to issue a RM on a property that has been titled to an Irrevocable Trust.

The reverse mortgage has become an improved solution in recent years for many seniors. It is still not the first line of defense in terms of depleting capital for your retirement. However, if you find yourself in such a situation in which you need the cash flow to maintain your lifestyle, it is certainly worth a look.