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What Is a Reverse Mortgage and Why Retirees Should Try to Avoid One

If you’re a homeowner aged 62 or older, you’re eligible for a reverse mortgage. If you’re retired or approaching retirement, there are a variety of reasons why you might consider this type of home loan. 

Many homeowners become interested in reverse mortgages as a way to keep living in their present homes. If you’re looking for money to pay for maintenance and repairs, or as a way to supplement your personal retirement plan, you might be wondering “Is a reverse mortgage a good option for me?”

What is a Reverse Mortgage

If you already own a home, then you’re probably familiar with a traditional home mortgage: you borrow money to buy a house and pay the loan back over time. Your home loan accrues interest (and equity) each month. 

Although a reverse mortgage uses your home as collateral, there are some key differences—hence the “reverse” part: First, the lender pays you money upfront. Interest still accrues every month, but you don’t have to pay the loan back until you sell the home or pass away. Second, your loan amount grows over time, as opposed to shrinking as you make monthly payments, like a regular mortgage. 

A reverse mortgage essentially converts the value of your home into cash. You can get your money in a lump sum, as an ongoing monthly payout, or as a line of credit. Sounds great, right? Well, yes and no. There are serious financial implications associated with this type of loan. 

Why We Only Recommend Reverse Mortgages As a Last Resort

At Wealth Legacy Institute, clients sometimes ask us if they should consider a reverse mortgage as part of their personal retirement plan. While the extra money reverse mortgages provide can be tempting, our recommendation as financial advisors is that you consider a reverse mortgage only as a last resort.

Despite the potential benefits, reverse mortgages are extremely expensive and for most retirees, the downsides far outweigh the advantages. Here’s a closer look:

Pros of a Reverse Mortgage

  • You don’t need a minimum amount of income to qualify 
  • You don’t have to make monthly repayments toward the loan balance
  • Your spouse may be able to remain in the home after your death, even if he or she is not listed on the mortgage 
  • Borrowers facing foreclosure can use a reverse mortgage to pay off an existing mortgage and potentially stop the foreclosure 

Cons of a Reverse Mortgage

  • When you die, your estate has to either pay back the loan or put the home up for sale to settle it
  • If you decide you want to move out (or if you move to a retirement home or a child’s home to receive care) you have only a year to pay off the loan 
  • You’ll pay lots of fees including closing costs and a monthly service fee of $30 to $35 per month, plus a monthly mortgage insurance premium
  • You owe more over time since you’re not making monthly payments; not to mention, all fees are compounded over time
  • It eats up your home equity, meaning that you have less to leave your heirs, not more.

First, Consider All Available Options

As with any financial decision, you need to fully understand what a reverse mortgage could mean for your finances, and for your retirement plan. As fiduciary financial advisors, our advice to retirees (or those approaching retirement) is to review all other options before considering a reverse mortgage. Carefully review the costs and benefits of staying versus moving and also consider alternatives such as:

  • Downsizing - Selling your current home and moving to a smaller one has the potential to increase your cash flow while giving you access to your existing home equity. 
  • Selling Your Home to Your Children - A sale-leaseback agreement lets you use the proceeds of your home sale to rent the property from the owner (in this case, your child).
  • Adjusting Your Retirement Lifestyle - Do you really need that fancy car, or is it just a status symbol? Reducing unnecessary expenses might allow you to stay in your home.
  • Refinancing - Find out whether refinancing your current home loan could result in lower monthly payments. Check the new terms closely so that you understand how it will affect your retirement years
  • Other Loans and Assistance - Check your state guidelines to see if they offer specialized loans or assistance. Most states, including Colorado, have one or more property tax relief programs, and the Administration for Community Living provides help with utilities, home repairs and other costs.

What to Consider If You’re Looking into a Reverse Mortgage

If none of the above are an option and you’ve decided a reverse mortgage is right for you, the Home Equity Conversion Mortgage (HECM) is your best option. HECM loans are government-backed by the Federal Housing Administration and have safeguards in place to protect consumers. This means an HECM is generally less expensive for borrowers. 

The drawback with HECM loans is they have lower caps on the amount of equity you can draw from your home. This forces many retirees to seek out a private lender for their reverse mortgage. If you decide to do this, it is prudent to check with multiple lenders because rates and fees can vary dramatically. 

No matter what kind of reverse mortgage you are looking at, ask yourself these key questions:

  • Who else should I involve in considering this loan? 
  • Which counselor should I choose? 
  • Have I given due consideration to all my choices? 
  • When would be the best time to take out a reverse mortgage?
  • What interest rate should I select? 
  • Which lender should I choose? 
  • How should I use this loan?

Set Yourself up for a Successful Retirement by Working With a Financial Advisor

The best way to avoid the need for a reverse mortgage is to have a financial plan in place from early on. The sooner you address your finances and start saving, the better your chances of staying on solid financial ground

A financial planner will help you take stock of your current situation and help you get where you want to be. The right planner will consider your emotional, personal and financial goals to help you create a plan that sticks.

Denver Fiduciary Guide

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