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Reverse Mortgages – The Basics

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Senator Thompson in Iowa.

 This is a guest post by Gary Foreman, of The Dollar Stretcher.com one of the oldest and best all-purpose financial blogs.  I don’t know about you but I find those reverse mortgage commercials featuring Fred Thompson to be nauseating and annoying.  Gary provides some objective information for those who might be considering this route.

With approximately 10,000 Baby Boomers reaching retirement age every day, it’s not surprising that more people are asking questions about reverse mortgages.  The concept of a reverse mortgage seems complicated at first. But if you break it down into it’s individual pieces it’s not that hard to understand.

Comparing a reverse mortgage to a traditional mortgage

With a traditional mortgage the lending institution gives you a large sum of money at closing that you use to buy the house from the seller. Generally you’ll make monthly payments to the lender to repay the loan. Hopefully someday you’ll have the mortgage paid off and own the house free and clear.

With a reverse mortgage you’re borrowing against the value of your home. Just like a traditional mortgage. Naturally you need to own your home outright or have significant equity.

Most reverse mortgage borrowers choose to take a monthly check from the lender although there are other options. So instead of repaying the mortgage, each month the amount they owe increases.

Beyond the basics

There are a number of requirements to qualify for a reverse mortgage.

  • The borrower must be 62 or older.
  • The home must be your principal residence.
  • Your home must meet all FHA property standards.

Besides these requirements, there are a few other facts about reverse mortgages that you’ll want to know.

  • How much money you can borrow will depend on your age, the equity in your home and the current interest rate.
  • The interest charged on the loan is variable, not fixed.
  • The lender will charge you an origination fee that will be included in the amount that you owe.
  • After you move from your home, the loan becomes due.
  • Any equity left after the loan is repaid goes to you or to your heirs.
  • The money you receive is a loan and generally not considered as ‘income’ for tax or Social Security purposes.

Advantages and disadvantages of a reverse mortgage

First, the positives.

You have flexibility in how much and how often you receive money. You can choose a fixed monthly payment, a line of credit, a lump sum or a combination.

You will never owe more than your home is worth. So when you finally move out and sell the home you won’t need to bring money to the closing table.

You still own the home. The title stays in your name(s), just like with a traditional mortgage.

You don’t repay the loan until the last surviving borrower dies, sells the home or moves out. If you need to move into a nursing home, you’ll have 12 months before the loan becomes due.

The income shouldn’t affect your current Social Security or Medicare benefits, though you should consult with the Social Security folks or your financial advisor.

Unlike other mortgages there aren’t any income requirements.

But, there are some negatives to consider before you apply for a reverse mortgage.

You’ll be charged origination fees and closing costs. There can also be ‘servicing fees’ during the life of the loan. They’ll be included in the amount you’ll owe when you pay off the mortgage. Often these fees are quite high.

Income from the reverse mortgage may affect your eligibility for Medicaid. Contact a CPA or Medicaid planner for details.

The amount you owe will steadily increase over time, even if you choose a single lump-sum payout.

Most reverse mortgages have variable interest rates. So the amount you owe could increase significantly if inflation returns and interest rates rise from our current low rates.

Unlike traditional mortgages, you generally can’t deduct interest paid on your federal income taxes until you sell the home.  I suggest consulting your tax advisor here.

Unless you’re prepared to repay the mortgage from home sale proceeds, you’ll be trapped in your home. No moving to a retirement community or condo.

You won’t be able to give or sell your home to a child without repaying the mortgage.

You’ll still need to pay insurance and taxes on your home. The typical responsibilities of a homeowner remain.

A few final cautions

You should also consider alternatives to a reverse mortgage. There may be other sources of income that are a better fit for your needs. This is especially true if you don’t require an additional regular monthly income stream.

Before you take out a reverse mortgage on your home make sure that you understand it thoroughly. There are some aspects that are a little unusual. Take your time. Don’t be rushed into a decision.

Remember, too, that people will be making money on your mortgage. And, sometimes unscrupulous people push financial products that aren’t well suited to the situation. So tread cautiously.

But, in the right situation, a reverse mortgage can be a viable solution for Baby Boomers and seniors looking for some extra retirement income.

For additional facts regarding reverse mortgages visit the HUD website.

Gary Foreman is a former financial planner who founded  The Dollar Stretcher.com website and newsletters.  The site features thousands of articles on how to save your valuable time and money including other articles on reverse mortgages.

Please contact me at 847-506-9827 for a complimentary 30-minute retirement planning consultation and to discuss all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.   

Photo credit:  Wikipedia

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