By: Investor Solutions, Inc.
If you are a homeowner approaching retirement with little savings, you may have at some point considered a reverse mortgage to supplement your income. For many house-rich, cash poor seniors, a reverse mortgage seems like an attractive option. And why wouldn’t it be?
By definition, a reverse mortgage allows homeowners to borrow against the equity of their home. To be eligible for a reverse mortgage, the owners of the home must be 62 years or older and own the house free and clear. The borrower receives a lump sum of cash, monthly payments or a line of credit. The cash from the loan is tax-free. And the best part, the loan does not need to be repaid until the owner sells his/her house or dies.
Sound too good to be true? It is.
This article will outline some of the pitfalls of using these tricky mortgages.
The Costs of a Reverse Mortgage
One of the major aspects of reverse mortgages borrowers tend of overlook is the cost. A reverse mortgage loan is expensive and can potentially eat into a big chunk of the equity of the home.
Borrowers should not underestimate the effects of the compounded interest charged on the loan. The amount you owe on a reverse mortgage generally grows over time. Interest is charged on the outstanding balance and added to the amount you owe each month. This means that your total debt increases over time as loan funds are advanced to you and interest accrues on the loan. Furthermore, interest for a reverse mortgage cannot be deducted on income taxes until you repay it.
For example, according to a Consumer Union report, a typical reverse mortgage may provide a borrower $300 a month with 1% interest compounded monthly. At the end of a 10 year loan term, the homeowner will have received $36,000 in payments but will owe $70,000 to the lender. The loan is almost twice as much as the payments received.
Many of the same costs that a borrower would pay to obtain a traditional mortgage loan apply to reverse mortgages too: origination fees, mortgage insurance premiums, appraisal costs and closing fees just to name a few. For example, under the HECM program, the origination fee is equal to the greater of $2,000 or 2 percent of the maximum claim amount. Currently, the FHA loan limits range from a low of $200,160 (for rural areas) to a high of $362,790 (for high-cost metropolitan areas). Therefore, the 2 percent origination fee generally ranges between $4,003 $200,160) and $7,256. Typically the loans are offset by these fees which further impact the equity value of the home.
The Future Impacts of a Reverse Mortgage
Borrowers should be aware of the impact the aforementioned costs could potentially have on their ability to make alternative accommodation arrangements in the future. If a retiree can no longer live in the house and is considering a senior housing facility, he/she may find that the net proceeds from the sale of his/her home, after repaying the loan and the accumulated interest, limit his/her choices.
Similarly, a reverse mortgage will impact the value of the estate. The net proceeds from the sale of the home, after repaying the loan and the accumulated interest, may limit the amount that would otherwise have been available for distribution to the heirs.
Beware of the Scams!
The reverse mortgage is a fairly new product in the mortgage industry. Very little public information is available on these types of mortgages. Consequently, homeowners, nationwide, have been cheated by unscrupulous reverse mortgage lenders.
Beware of lenders that have not been approved by the Department of Housing and Urban Development (HUD). It is very important that you verify at http://www.hud.gov that your Reverse Mortgage Loan Specialist has all HUD required approvals. There have been reports of lenders trying to charge rates and fees in excess of those mandated by HUD. Unlike traditional mortgages, The Department of Urban Development actually dictates what interest rate all properly licensed Reverse Mortgage lenders must use so the rates should not vary from one lender to another.
Scams have also been reported on the internet where dishonest lenders have purposely plugged in incorrect interest rates in their online calculator which resulted in inflated cash-out values.
Beware of “equity-sharing” or “shared appreciation” features. Be cautious of anyone offering the opportunity to obtain more money in exchange for giving up a percentage of the future value of the home.
In closing, a reverse mortgage offers a unique way for homeowners to retire. However, using your house as a golden parachute into retirement is a poor substitute for a sound retirement planning. The best solution for securing your future retirement lies in establishing a savings plan early, investing wisely and setting a reasonable withdrawal strategy at retirement.