Getting income for life and
staying in your home as long as you want sounds like the perfect
combination. If you're cash-strapped and having trouble making ends
meet, a product that promised a deal like that would look like a
life-saver.
For homeowners over 62, reverse mortgages offer exactly that promise. To seniors who struggle with ever-increasing costs of living and falling CD income, it sounds like the perfect solution -- they can supplement their cash flow without having to sell their home and move.
But before you or your loved ones decide on a reverse mortgage, make
sure you understand its limitations and shortfalls as well as its
promises.
What a reverse mortgage does
Reverse
mortgages allow you to tap into your home's equity without having to
sell it. Unlike regular mortgages, you don't have to make any monthly
payments to your lender, and the lender can't collect the principal
until you sell your home, pass away, or move to another primary
residence, such as a nursing home.
Depending on your age and the value of your home, a lender will offer
you a variety of payment options. One option is to take a lump sum. You
can also establish a line of credit you can draw on at will, or get
fixed monthly payments as long as you stay in your home.
You can find reverse mortgages from many sources. The Federal Housing
Administration (FHA) insures the most popular type of reverse mortgage,
known as Home Equity Conversion Mortgages. They're offered through
private lenders. Some large banks, such as Wells Fargo (NYSE: WFC) and Bank of America (NYSE: BAC), offer them to borrowers across the country. Regional banks like Fifth Third (Nasdaq: FITB) and M&T Bank (NYSE: MTB) lend money within their respective business areas.
In addition to government-insured loans, some lenders have private proprietary reverse mortgage products. For instance, Fannie Mae (NYSE: FNM) offers a reverse mortgage with limits that are higher than the FHA's in some locations.
Equity going backward
With reverse
mortgages, money flows in the opposite direction from a typical
mortgage -- your lender pays you. However, as the Motley Fool's Rule Your Retirement
newsletter has discussed in detail, another aspect of home financing is
also reversed: Rather than slowly gaining equity in your property, your
equity is likely to go down over time with a reverse mortgage.
There are two reasons for this. First, if you take a monthly payment,
then each month, you'll add to the outstanding balance of the loan.
Second, as with any other loan, your lender will charge you interest on
that balance. If your total loan balance grows faster than the value of
your property -- which is certainly possible, especially with home prices falling dramatically in many parts of the country -- then you'll have less equity.
Traps for the unwary
While reverse mortgages
can give you an easy way to get to your home's equity, you should
understand a few things when considering them:
- Even if your home is paid off completely, you won't be able to borrow the full value of it. For instance, using a calculator
from the National Reverse Mortgage Lenders Association website, a
62-year-old living in Houston would only qualify for a $125,000 loan on
a home worth $200,000.
- Moreover, closing costs
can be substantial -- well above what you'd pay on a typical mortgage.
Using the same example, the calculator estimates fees and closing costs
totaling over $16,500, leaving you with a lump sum of less than
$108,500.
- In general, the older you are and the more your
home is worth, the more you'll be able to get from a reverse
mortgage. So if you wait until you really need a reverse mortgage,
you'll often get better payouts.
- Similarly, don't take out
more money than you need. Monthly payments or a line of credit that you
draw from gradually will cost a lot less in interest than a lump sum.
Although you should keep these thoughts in mind, a reverse mortgage
still might be a useful part of your financial plan for your retirement
years. If you'd like to learn more, help yourself to a complimentary 30-day guest pass to Rule Your Retirement. You'll get access to back issues discussing reverse mortgages and much more. It's free, with no obligation to subscribe.
For more retirement advice, read about:
