One of the greatest challenges facing retirees, particularly in today’s low-interest rate environment, is generating sufficient income for everyday living expenses. And for the 41 percent of Americans aged 55 to 64 with no retirement savings, their home may become their most effective way to fund retirement.
The combination of those two trends makes reverse mortgages so appealing to so many people. With a reverse mortgage, a homeowner age 62 or older can turn the value of his or her home into cash, without having to make monthly payments or moving. You can take the cash as a lump sum, in equal installments, or as needed through a line of credit.
As Walter Updegrave recently noted in his RealDealRetirement blog, a 65-year-old with a $250,000 home might be able to borrow up to $127,000 through a reverse mortgage, according to the Boston College Center for Retirement Research.
But reverse mortgages have drawbacks, too.
A reverse mortgage can be an extremely expensive and tricky way to borrow, so you need to understand the risks and costs before proceeding. It ensures that a significant portion of your home equity will be given to the bank in the form of fees and interest, rather than to your own retirement funds or your estate.
Implications For Your Family
A reverse mortgage can also have serious implications for your surviving spouse and family after you die — a family member living in the house who didn’t go in on the loan could be forced to move out — so you’ll need to factor this in when deciding whether to sign up.
It’s not too surprising that The Consumer Financial Protection Bureau (CFPB) has received 1,200 reverse mortgage complaints since December 2011, according to the federal agency’s recent report about them. As the report said: “Many older consumers and their families are confused and frustrated by the terms and conditions of reverse mortgages.”
So here’s a guide to the pros and cons of reverse mortgages:
Reverse Mortgage Terms and Fees
With a reverse mortgage, you remain the owner of your home. You convert your equity into cash and the loan doesn’t need to be repaid until the last surviving borrower dies, sells the home or moves out.
In most cases, however, the lender can terminate the loan if you fail to pay your property taxes or homeowner’s insurance or don’t maintain your home.
The costs of a reverse mortgage are significant, especially in the first year. Interest rates tend to be higher than on standard mortgages and interest is generally compounding. In addition, there are a number of required upfront costs, including:
A mortgage origination premium: Most reverse mortgages are federally insured and the borrower pays for that insurance. The cost is 0.5 percent of the appraised value of the home (up to $625,500) if you borrow less than 60 percent of your initial principal limit during the first 12 months. If you borrow more than that, you’ll have to pay a steep 2.5 percent.
Origination fee: The lender can charge up to $6,000 to compensate for the cost of processing the loan. The size of the fee depends on your home’s value.
Closing costs: Their amount varies, too, but they’re similar to what you’d pay for a traditional mortgage. You’ll likely pay for a credit check, an appraisal, a title search, a survey, an inspection, a recording fee, taxes and other fees.
Once you have the loan, you’ll be charged interest on the amount borrowed (which includes an annual mortgage insurance premium) plus up to $35 a month in fees.
Eligibility and Counseling
Due to a recent change in the rules, to qualify for a reverse mortgage, you’ll need to prove that you can afford to pay the property taxes and homeowner’s insurance from your retirement income. The lender will review your income, assets and credit history to make the determination.
Also, before you get the reverse mortgage, you need to get counseling about it from a U.S. Department of Housing and Urban Development (HUD) sanctioned counselor. To find one, you’d go to HUD’s website or call 800-569-4287.
Key Risks to Consider
At the end of the loan, your home is typically sold and the proceeds are used to pay off the mortgage. Because of the large upfront costs and the compounding interest, a significant portion of your equity will be used to pay the interest and fees. That means you’ll be significantly reducing any inheritance you hope to leave to your surviving spouse, family or charity.
Another risk is the possibility that your spouse will be forced to sell your home or deal with foreclosure proceedings if she or he didn’t take out the reverse mortgage with you. At the very least, you’ll want to speak to any family member living in the home who wasn’t a co-borrower to make sure they have a plan once you die.
In the CFPB’s report, many reverse mortgage borrowers complained they couldn’t refinance the loans because they didn’t have enough equity in their homes. The lesson: Don’t underestimate how quickly a reverse mortgage’s compounding interest erodes your equity.
Another big complaint: reverse mortgage lenders refusal to let the borrowers change the terms of their loans by, say, lowering the interest rate or adding borrowers to the loan to ensure they wouldn’t be evicted when the original borrower dies.
If you have a problem with a reverse mortgage, submit a complaint to the CFPB online or call 855-411-2372. The agency says it will work to get you a response within 15 days.
The Bottom Line
Here’s the bottom line: Years of hard work created your home equity and you should make the most of that money during your retirement.
Before deciding to use a reverse mortgage to fund your ongoing retirement income needs, think hard about whether you might rather sell your home and downsize to free up some cash. Or you might consider either taking out a new mortgage and getting a lump-sum payment through a cash-out refinance or getting a tax-deductible home-equity loan or home-equity line.