5 Things To Consider Before You Jump In
If you’re over 62 and own a home, you probably qualify for a reverse mortgage. Qualifying does not, however, mean it’s necessarily the right choice.
For those unfamiliar with the term, a reverse mortgage enables you to take out a loan on the equity you’ve earned on your house. If you’ve lived there a long time, odds are that you’ve paid down a good chunk—if not all—of the principal mortgage. Under that scenario, a reverse mortgage could offer a welcome influx of cash. There are, however, situations in which borrowing against your equity can be a bad financial choice. Here are a few things to consider as you ponder if a reverse mortgage is the right financial choice for you. These are meant as starting points before you talk to your financial advisor.
The Potential Plusses
You Could Pay Off Your Existing Mortgage
The best-case scenario for a reverse mortgage would occur if you owe less on your mortgage than the value of your home. This would allow you to then pay off your mortgage in full and potentially have a good chunk of money left over to pay down other debt that you may have. Free and Clear, a mortgage website, offers this example:
[…] a borrower with 10 years remaining on a $300,000 30-year fixed-rate mortgage with a 5% interest rate has an approximately $148,000 mortgage balance and a $1,610 monthly mortgage payment. Assuming the value of the borrower’s property is $400,000, the borrower can obtain an approximately $240,000 reverse mortgage. After the borrower uses the proceeds from the reverse mortgage to pay off his or her existing mortgage balance of $148,000 and closing costs of approximately $5,000, the borrower has $87,000 remaining that can be used for a variety of purposes, including paying off debt.
If paying off debt and getting an influx of cash make sense for your finances, a reverse mortgage could be a good choice.
You Could Avoid Your Biggest Monthly Payment
One of the most popular reasons to get a reverse mortgage is to eliminate monthly mortgage payments. When you obtain a reverse mortgage instead of making a monthly payment and paying down your mortgage over time, your monthly interest expense is added to the principal balance of the mortgage. This means your reverse mortgage balance increases over time, but it also means you have no monthly payment.
This could be beneficial for a number of reasons. Maybe you’re trying to pay off another debt (student loans, credit cards, unexpected medical bills) but are having trouble because of having a fixed income or reduced earning power. Eliminating your mortgage payment until a later date could help you get through that bind. That being said, there are a number of reasons this could come back to bite you in the behind, which we’ll address in a minute.
You Could Make Long-Overdue Home Improvements
Reverse mortgages can also make sense for funding large home improvement projects or emergency needs such as replacing a septic system or furnace. Many of us put off more costly home improvements or repairs. It’s like the frog in boiling water metaphor: If you place a frog in boiling water, it will immediately jump out. If you place the frog into warm water but gradually heat it to a boil the frog won’t notice and you find yourself with a messy frog soup situation. Many retirees inadvertently turn a blind eye to the state of the home they love, which can lead to costly situations down the road. A reverse mortgage gives people on a fixed income the ability to fund large projects without increasing their monthly payments by a significant amount. As such, this can be a much more attractive option than a home equity loan, line of credit, or a cash-out refinancing, as those all require the borrower to make ongoing monthly loan payments.
Reverse Mortgages Aren’t Free
Reverse mortgages have costs that aren’t readily apparent, such as lender fees (up to $6,000), FHA insurance charges, and hefty closing costs. While these can be added to the loan balance, it’s important to remember they don’t disappear. The bottom line is that by taking out a reverse mortgage you are losing equity in what is most likely your biggest financial asset while assuming more debt.
Just because your mortgage is taken care of doesn’t mean you stop paying all the other costs associated with your home. You are still responsible for paying the property taxes, homeowners insurance, HOA fees, and any other costs you regularly incur. You might also pay pesky service fees each month that are associated with fluctuating interest rates. You are also required to be living in the home as your main place of residence. If at any point during the loan you become delinquent on any of these factors, you risk being at default and losing your home to foreclosure.
Furthermore, there are considerations based on age, health, and inheritance. If your health is declining, a reverse mortgage could cause you to lose your home if you need to be in a hospital or specialized care facility for an extended period of time. If you have a spouse or roommate, they need to be on the paperwork or they risk losing their home upon your hospitalization or death as well. And finally, a reverse mortgage could impact what your heirs eventually inherit. If more is owed to the reverse mortgage than the value of the home when you die, they might have to sell the house to pay it off or turn it over to the lender.
The Bottom Line? Consult an Expert
While a reverse mortgage can be beneficial for some, it can also have more drawbacks than benefits in certain scenarios. Consulting with a financial advisor before even beginning to shop for a loan is critical, as they will be more familiar with any fine print that could lead to disaster, and also have experience in understanding how reverse mortgages work in all kinds of scenarios. There are multiple types of reverse mortgages, and some of them have very stringent requirements. Once you’ve consulted an expert, they will often recommend interviewing at least three lenders to get the best deal. And finally, be very wary of anyone doing a sales pitch trying to convince you to enter into a reverse mortgage. Often these entities have malicious intent, and many seniors have been left with crippling debt and loss of property because they unknowingly entered into a bad contract.