Reverse mortgages are designed for retired or elderly people who are nearing (or in) retirement. Many retirees find that social security income is not enough when it comes to retirement, especially if they do not have a sufficient pension to back it up with. This often causes retirees to turn to reverse mortgages as a way of extracting some of the equity from their homes and having more income available for their retired lives.
A reverse mortgage enables homeowners who are 62 years old (or older) to convert a portion of the equity of their home into cash, allowing them to subsidize their retirement. This money may be used for things such as medical bills or other expenses, and presents an alternative to selling one’s home or taking out a second mortgage.
As the name suggests, a reverse mortgage is like a regular mortgage in reverse. Instead of the homeowner making payments to the lender, the homeowner receives money from the lender. This lender then gradually gains additional equity in the retiree’s home. Generally speaking, reverse mortgage advances are not taxable, and do not affect social security or Medicare benefits. This makes them very appealing to seniors.
There are 3 main types of reverse mortgage to choose from, and they all work in slightly different ways.
Single-Purpose Reverse Mortgage
A single purpose reverse mortgage is provided by a state/local government agency or non-profit organization. It is generally the cheapest option, though it is also the most restrictive. As the name suggests, it can only be used for one purpose (i.e. to pay for one thing) and this purpose is usually stipulated by the lender.
Home Equity Conversion Mortgage
These are sometimes called “HECM” mortgages, and these types of mortgages are backed the US Department of Housing and Urban Development (HUD).
Proprietary Reverse Mortgage
These are private loans that are backed by the companies that developed them. Private loans often come with less protection than federal loans, so watch out for this.
Income from HECM and Proprietary Reverse Mortgages can be used for a multitude of things, such as healthcare costs and retirement funds. These types of loans will usually require you to attend a counselling session with a HUD-certified counsellor who is there to advise you on your options and help you to decide which option is best for you. They will also outline the financial implications of the mortgage that you’re taking out, and will detail what will happen to your home and your estate after you die. You will have to pay a fee for this counselling session, though this fee can be taken out of the mortgage funds themselves if necessary.
The amount you can borrow with a reverse mortgage depends on your age, the appraised value of your home, the interest rate, and the FHA’s mortgage limits for your area. Generally speaking, the older you are, the more valuable your home is, and the lower the initial interest rate – the more you’ll be able to borrow.
Bear in mind that 18% of reverse mortgages end up defaulting, so they are by no means the safest way to take out a loan. It also worth considering that you risk your home being foreclosed under certain circumstances, and there may be implications on your family’s inheritance after your death.