If you watch television at all, you’re almost bound to have seen either former senator Fred Thompson or actor Henry Winkler, “The Fonz” from the popular sit-com “Happy Days,” touting the advantages of a reverse mortgage for senior citizens. Both ads make a reverse mortgage sound like an easy way to turn the equity in your home into ready cash that can be used for anything. The ads also imply that the borrower never has to pay back the money loaned. On the surface, it sounds like a great way for seniors to tap into the equity they have in their homes so they can live more comfortably.
Well, it’s not quite that simple. Nobody is going to lend you money – because that’s what a reverse mortgage really is, a loan to the homeowner based on the equity the owner has in the home – without expecting it to be repaid, with fees and interest. Always remember the old saying, “If something sounds too good to be true, it probably is.”
Here are some basics on how a reverse mortgage works. The borrower has to be at least 62 years old and must occupy a home as their principal residence. The size of the loan someone may qualify for depends on several factors: the age of the borrower; the extent of ownership, (equity), the borrower has in the home, the appraised value of the home, less the projected cost of any repairs that need to made for health or safety reasons; the interest rate of the loan, which is periodically added to the amount of the loan; and whether the loan is paid to the borrower as a line of credit, cash payments each month to the borrower, a lump sum payment all at once, or a combination of the foregoing, selected by the borrower. Needless to say, the interests rates charged are going to vary depending on the method selected. The highest interest rate, incidentally, goes with the lump sum payment.
Now, when does the loan have to be repaid? (Surely, no one was thinking that any lender was going to lend homeowners money based on the equity in their home and not expect to be repaid – with interest!) The loan is due when the borrower sells the house or fails to keep the taxes or insurance current or moves out of the house for more than twelve consecutive months or passes away. When the mortgage becomes due, the borrower or his/her heirs of the estate have the choice of refinancing and keeping the home or selling it and keeping any remaining equity or turning the home over to the lender. Most people who use a reverse mortgage usually have no heirs; and, when the last borrower passes away, the lender takes possession of the house and resells it to recover at least the amount lent to the now-deceased borrower.
So, before considering a reverse mortgage it’s important to keep in mind that, if the homeowners plan to leave anything to their children or other family members, their house isn’t going to be part of the bequest – unless the children or other family members understand that, to keep the house, they will have to repay the amount of the loan, plus interest. This approach might not be bad if the house is worth substantially more than the amount owed as a result of the reverse mortgage. For family members who either plan to sell the house or live in it, paying off the loan might be a relatively inexpensive ways to acquire a home.
Just for the sake of fairness, here are some things to think about if you’re considering a reverse mortgage. Keeping in mind that a reverse mortgage is really a loan, there are going to be loan-related fees, like an origination fee, for example. Other fees are typically higher since the loan isn’t based on income or a credit score. The interest rate on a reverse mortgage is often higher than the rate on, say, a traditional home equity loan. Your heirs might not get the house. Since the borrower isn’t expected to make payments on the loan, the loan is paid off when the home is sold. If, for some reason, the borrower decides to downsize to a smaller house or move into a long-term healthcare facility, the borrower has to start repaying the reverse mortgage to the lender. Finally, the borrower is still responsible for normal homeowner costs such as property taxes, homeowner’s insurance, and regular maintenance on the property.
In discussions with a banker, it became clear to me that a reverse mortgage is really a “last resort” for people who need the money to do things like put food on the table and have no other source of income. In most instances a home equity loan makes more financial sense. For those who find that their present home is too much to take care of any longer, selling the home, buying a smaller one, and pocketing the difference for living expenses also makes more sense.
The only other reason to consider a reverse mortgage seriously would be the situation in which an individual or couple has no heirs they want to inherit a home and decide they don’t care if the bank takes possession of their property after they’re gone!
The best advice, however, if you’ve been enticed by Fred Thompson or Henry Winkler to consider a reverse mortgage seriously is to talk to your local banker before calling that “number on the screen.” You’ll get far more personalized advice on what the best decision is for you.
That’s –30—for this week.