This week’s topic is one that draws a lot of interest, both pro and con, in the financial press – reverse mortgages. Let me begin by explaining them. A reverse mortgage gets its name because, in many respects, it is the mirror image of a conventional mortgage. For example, in a conventional mortgage the balance owed goes down over time; in a reverse mortgage it goes up over time. In a conventional mortgage, interest is front loaded, i.e., you pay a disproportionate share of the interest in the early years and less interest as time goes on. In a reverse mortgage, the interest accumulation is lower in early years and higher in later years. Finally, unlike a conventional mortgage, a reverse mortgage is not dependent on your financial situation or your health.
A reverse mortgage is a loan to a homeowner or homeowners who are age 62 or older. If there is any existing debt against the home, it must be paid off as part of the reverse mortgage as the reverse mortgage must be a prime lien. Once the home is appraised, the reverse mortgage lender agrees to lend about 60% of the appraised value of the property to the homeowners. The homeowners can take the loan proceeds in lump sum, in payments over their lifetime or in a line of credit to be drawn down as they see fit; the homeowners can select any one or a combination of these options. As the funds are drawn, the lender begins accumulating the mortgage balance comprised of the amounts outstanding plus interest. Obviously, interest charges increase as the amount outstanding grows.
Unlike a conventional mortgage, there are no monthly payments required in a reverse mortgage; the balance merely accumulates until the house is vacant due to death or a move out. Within one year of death or vacancy (or at the time of sale if the house is sold sooner than a year), the reverse mortgage must be paid in full. If the proceeds from the sale of the house are more than the balance owed on the reverse mortgage, the homeowners or their heirs get to keep the difference. However, if the balance outstanding exceeds the sale proceeds, the homeowners or their heirs are not responsible for the excess – that is paid by the Federal Housing Authority (FHA) as every reverse mortgage is an FHA-insured loan. So, the worst case your heirs would realize is not getting any equity from your house; they cannot be liable for any excess loan balance.
Why do people consider getting a reverse mortgage (other than because Robert Wagner and Fred Thompson endorse them on television)? People use a reverse mortgage to supplement their monthly income (remember that payments can be made for life, guaranteed by the reverse mortgage lender), to retire debt that requires monthly payments with a debt that does not require payments, to provide funds for necessary repairs without taking on monthly payments or to meet emergency situations. One reason NOT to do a reverse mortgage is to take the funds and invest them with the hope that you will earn more than the loan costs; I know financial advisors who have advocated that and I believe it to be unethical and inappropriate.
These days, there are a variety of reverse mortgage programs from which to choose. Some offer fixed interest rates while others offer variable or floating rates. Some have larger closing costs but lower ongoing costs while others trade a lower closing cost for higher monthly costs. The best way to explore the issue is to meet with a reverse mortgage specialist and get all the facts specific to your situation. Linked below is an article posted on our website that is a good quick summary of the key issues. I have helped many people investigate this option and know a great deal about how these programs work. Let me know if I can help you or a member of your family.