What Is A Reverse Mortgage And How Does It Work?
What Is A Reverse Mortgage?
Reverse mortgages are loans against the equity in your home. They are typically available to those 55 and over (this varies depending on your loan provider). The goal is to give homeowners the benefit of using the equity they’ve built up in their home to fund their lifestyle while not forcing them out of their home.
For most people, the dream of home ownership represents a stable future and a comfortable retirement. Paying off your home is only one piece of the retirement puzzle, and often those who worked hard to own their home find themselves ‘house poor’ when it’s time to retire.
The dilemma is obvious. Your home has probably appreciated in value significantly since you bought it – but so have all the others. You have a ton of equity, but that money is locked up in your house and is inaccessible for day-to-day living expenses, medical emergencies, repairs, etc.
Enter the reverse mortgage.
How Do Reverse Mortgages Work?
While the terms differ by institution, the general idea is that you borrow a percentage of the equity in your home. Unlike a regular mortgage, you don’t make regular payments back on the loan.
The loan can be paid to you in several ways:
– Lump Sum: Receive the entire amount you borrowed right at the beginning.
– Annuity: Receive monthly payments that can help your cash-flow.
– Line of Credit: Use only what you need, when you need it.
– Combinations: Some institutions will allow you to combine the above, for example taking out an initial lump sum of a portion and then receiving an annuity for the rest.
For cash-strapped seniors, this sounds like a no-brainer. You receive the equity from your home (remember this is your own money), and only pay back the money when you die, sell your home, or move out permanently.
Drawbacks To Reverse Mortgages
With a regular mortgage, you’re paying back the loan regularly, which helps keep the interest charges down. With a reverse mortgage, since you’re not making constant payments, the interest is simply growing and growing. That means when it finally comes time to pay back the loan, you’ll be paying back SIGNIFICANTLY more than you borrowed.
Combined with the fact that the interest rates charged for a reverse mortgage are substantially higher than a regular mortgage, you could end up paying almost double the amount that you borrowed.
Advantages To Reverse Mortgages
While the disadvantages sound scary, the total amount you owe will never be greater than the fair market value of your home. This means you’ll never be kicked out of your home or owe extra when you sell.
Alternatives To Reverse Mortgages
You will only get approved for a reverse mortgage if you have substantial equity in your home.
If you DO have that equity, a home equity line of credit (HELOC) may be a better option. With a HELOC you’ll have to start paying back anything you borrow right away, but the interest rate will be much lower and the immediate payments will help keep ballooning interest charges at bay.
It’s possible that you could move to a smaller home or condo and end up with a lump of cash from the sale of your current home. Moving might be difficult, but it could also mean less maintenance work and above all, you’ll still have an appreciating asset to pass on to your family when you die.
Selling your home and moving into a rental will give you all the cash-flow you need. The proceeds from the sale of your home will of course start shrinking, but if invested properly they could cover a good portion of your lifestyle. Best of all, the money is all yours when you sell, and you’ll never have to worry about paying back debts or interest payments.
Is A Reverse Mortgage Right For You?
If you need the money, don’t qualify for other lending options, and aren’t concerned with how much your estate is worth when you die, a reverse mortgage may be right for you. If however you want to have something to pass on to your family, and have the patience to look at other options, there are most certainly cheaper and better options available.