While there are many valid reasons for renting in retirement, people who own a home can still take advantage of a reverse mortgage if they need a financial boost. Not long ago, financial planners looked harshly upon reverse mortgages, which allow homeowners over the age of 62 to capitalize on equity while still living in the home.
Reverse mortgages were largely considered a last resort that should be avoided if at all possible. However, the thinking about reverse mortgages has largely changed, especially as older individuals are sitting on very high levels of equity and struggling to maximize their retirement income.
Why Retirees May Want to Take out a Reverse Mortgage
Of course, a reverse mortgage comes with a number of downsides, such as steep upfront costs, so you must be judicious about using one. With this in mind, a reverse mortgage can become a valuable tool.
One way to leverage reverse mortgages is to use them essentially as a line of credit. You can take money when necessary, pay interest only on what is used, and avoid paying taxes on the proceeds. Some retirees have used a reverse mortgage to avoid tapping into their portfolios in a down market. In that sense, the tool can be used to mitigate investment risk and avoid taking losses on a portfolio.
Retirees have used reverse mortgages in several other ways. Some have taken a reverse mortgage to pay off their traditional mortgage and thereby increase cash flow in retirement, which can make sense in some situations. Others have used a reverse mortgage as a sort of insurance policy against long-term healthcare needs, which can keep people from hurting themselves financially in the long run. For example, people who feel like they need to claim Social Security early and forego the higher payout of waiting longer may be able to hold off with a reverse mortgage and maximize their cash flow down the line.
The Important Details to Know about Reverse Mortgages
Before making use of a reverse mortgage, you should understand its unique pros and cons. The main catch is that the loan needs to be repaid, theoretically through the proceeds of selling a home. Interest does accrue on the equity that you access through the reverse mortgage, which can add to the money you need to pay back. The fees involved can be significant enough to discourage people from taking out a reverse mortgage.
Generally, you will pay back the loan when your home is sold. However, if all individuals on the loan pass away prior to it being repaid, then any heirs become responsible for repayments, which may involve the stress of putting the home on the market as well as covering real estate fees.
For the most part, you should look for reverse mortgages from lenders who have earned approval through the Federal Housing Authority’s Home Equity Conversion Mortgage (HECM) program. Retirees will only qualify if they are at least 62 and have paid off their mortgage. Plus, they must still live in the house to qualify for the loan. Other stipulations for the homeowner may also apply, such as completing counseling sessions and pending credit approval.
You must also still cover the costs of maintenance, pay homeowner dues, and make sure the home is insured. The maximum that you can borrow depends on a number of different factors, including interest rates, the value of the home, and your age. Plus, the age of your spouse matters. Altogether, no loan under HECM can exceed $726,525.
The Fees Involved with Obtaining a Reverse Mortgage
Borrowers also have different options for receiving the loan. With a fixed-rate deal, you can take the amount as a lump sum, although it does not always make sense to do so. Individuals who opt for an adjustable-rate loan can choose monthly payments or a line of credit. The fees are charged whether you choose to use the money right away or keep it as a contingency plan. The origination fees can be up to 2 percent for the first $200,000 and then 1 percent for the remaining amount, with an overall cap of $6,000, which is quite considerable.
You will also need to pay mortgage insurance that is 2 percent of the maximum claim amount and then .5 percent of the outstanding balance. Insurance is an annual charge. This insurance covers the reverse mortgage if you cannot pay, and covers the difference if the value of the property falls below the outstanding loan balance.
There may be additional charges on a reverse mortgage as well. For example, you’ll also pay monthly service fees, as much as $35. Other possible charges include appraisal fees, escrow fees, credit report fees, and document preparation. All in, a loan of up to $200,000 could involve $10,000 in upfront fees, which is even more problematic since these charges are often rolled into a loan balance and may not be apparent. Moreover, ongoing fees including service charges and insurance premiums, which can total up to $1,400 per year.