Owning a home is an excellent investment. Aside from the property itself, it can also help you get retirement income through a reverse mortgage.
Say you’ve recently retired and are worried you can’t keep up with your expenses. This is where a reverse mortgage will come in handy, especially if your home has high value.
In this article, we’ll discuss some of the things you need to know about reverse mortgages. Read on for a brief guide to help you decide if a reverse mortgage is for you.
The Pros and Cons of Reverse Mortgage
Now that you understand what a reverse mortgage is, it’s time to dig deeper.
Of course, reverse mortgages have pros and cons. Depending on your needs and financial situation, a reverse mortgage can benefit you or put you into trouble.
Below are some of the pros and cons of reverse mortgages you might want to consider before getting one.
Pros of a Reverse Mortgage
Here are the pros of getting a reverse mortgage:
1. You have a steady income source during retirement.
Like we’ve said, you’ll receive funds from your reverse mortgage as long as you stay in your home. For those who struggle to keep up with their expenses, reverse mortgages are a way to finance these costs efficiently.
However, keep in mind that lenders consider several factors to determine how much you can borrow.
Additionally, you have options to either receive funds for the rest of your life or receive them for a specific period.
2. Reverse mortgages are tax-free.
A reverse mortgage can help if you want to receive retirement income without paying taxes for it.
Also, the IRS considers reverse mortgages a loan and not income, which means it wouldn’t affect your Social Security and Medicare benefits.
3. You don’t have to worry about early repayment.
Reverse mortgages should be repaid if you die, move out, or sell your home. Unless any of these happens, your lender can’t force you into early repayment.
If you decide to sell your home, you must pay off your remaining balance. But, if it sells for larger than what you owe, you’re entitled to the difference and use it for another purpose.
If you die, your heirs might be required to pay your balance. If they can’t afford the loan, they might be required to sell the home to pay the balance.
Cons of a Reverse Mortgage
Here are the cons of getting a reverse mortgage:
1. There’s an age requirement of 62.
If you want to get a reverse mortgage, you have to be at least 62. Also, if you have a younger spouse, it might be challenging to get a reverse mortgage.
However, there’s a workaround you can use. You can deed the home to your spouse if they’re older, but this might cause issues later on.
Generally, if you’re not qualified for a reverse mortgage, it might be better to wait until you meet this requirement.
2. Reverse mortgages are quite costly.
As shown earlier, there are a lot of fees and costs that come with a reverse mortgage. And while they can be rolled into your loan, doing so will decrease the funds you’ll be able to get.
3. Foreclosure can make you lose your home.
If you’re not able to pay these, your home might get foreclosed. With this, you must ensure that you can afford to pay these expenses.
Reverse Mortgage Explained
A short answer is that a reverse mortgage is a type of negative amortization loan.
A reverse mortgage is offered to homeowners who are 62 and older, who’ve already paid off their mortgage. Through a reverse mortgage, homeowners can borrow part of their home’s equity as a source of tax-free income.
Unlike a regular mortgage that requires homeowners to pay lenders, the lenders pay the homeowners in a reverse mortgage. Additionally, a reverse mortgage also enables homeowners to continue living in their homes.
Moreover, homeowners who get a reverse mortgage aren’t charged monthly payments. However, the loan must be paid off when the borrower dies, moves out, or sells the home.
How Does It Work?
As we’ve mentioned, reverse mortgages are a type of negative amortization loan, which means that your balance increases over time.
Say you borrow $100,000. With a reverse mortgage, you will owe more than $100,000 if you pass away, sell your home, or move. Also, your payment amount will depend on the interest rate of the reverse mortgage.
Additionally, there are five ways to withdraw your funds from a reverse mortgage. We’ll briefly discuss them below to give you an idea of how each works.
With a lump-sum, you’re allowed to take the money you borrowed upfront. However, lenders will require you to take the total amount in two sums, with a one-year gap between the two. Typically, lenders charge the outstanding balance of lump-sum reverse mortgages with fixed interest rates.
2. Tenure Plan
Tenure plans enable you to receive the money as monthly payments. Generally, you accept tenure payments as long as you stay in your home. And, unlike a lump-sum, tenure plans have an adjustable interest rate.
3. Term Payment
Term payments are similar to tenure plans, as both are sent as monthly payments and have adjustable interest rates. The difference is that term payments only last for a specific timeframe. Also, term payments are typically larger than tenure payments.
4. Credit Line
Unlike what we’ve already mentioned, getting a credit line won’t give you any cash. Instead, lenders provide you with a credit line that you can use at any time. Additionally, this line increases over time depending on the interest rate.
Mix-and-match is probably the most flexible, as it’s a combination of what’s mentioned above. For instance, with a mix-and-match, you can take a lump-sum of $10,000 and monthly term payments of $500. Also, with mix-and-match, you can change your options by paying a fee.
Types of Reverse Mortgage
In addition to the different ways to get funds, there are types of reverse mortgages. Of course, each type will fit a different financial need.
1. Home Equity Conversion Mortgage (HECM)
Among the three types, HECM is the most popular type of reverse mortgage.
This type is a government-issued mortgage that typically has higher upfront expenses. But, with a HECM, you can use the funds for any purpose.
Also, HECMs are widely available. However, they’re only provided lenders approved by the Federal Housing Administration (FHA). And, if you’re planning to get a HECM, you’re required to attend HUD-approved counseling.
Unlike HECMs, proprietary reverse mortgages are private loans not offered by the government. Typically, this type of reverse mortgage gives larger loan advances.
This type is beneficial if your home has a high value.
This last type of reverse mortgage isn’t as common as the other two. It’s also usually offered by nonprofit institutions and state agencies.
Also, unlike the other two, single-purpose reverse mortgages can be used only for specific purposes. Typically, they’re used for a handicap-accessible remodel.
How Much Does It Cost?
Like regular mortgages, reverse mortgages aren’t cheap. However, most HECMs allow you to include other costs into the loan, so you don’t spend so much money out of pocket.
However, doing this decreases the total amount of money you can get from the loan.
As HECMs are the most common, we’ll be discussing how much HECMs cost. Below are the fees you will incur if you get one, according to the HUD:
- Mortgage insurance premiums (MIP)
At closing, you’ll be charged with a 2% initial MIP. There’s also an annual MIP equivalent to 0.5% of your balance. You can pay the MIP upfront or roll it into your loan.
- Origination fee
Lenders charge an origination fee to process the HECM. Typically, origination fees cost you $2,500.
However, it can also be 2% of your home values’ first $200,000 added to 1% of the amount above $200,000. Just know that lenders charge you with whichever is greater. But, know that origination fees can only go up to $6,000.
- Servicing fee
In addition to the origination fee, lenders also charge you a monthly servicing fee. This allows them to monitor and maintain your HECM for its duration.
Typically, these monthly fees don’t exceed $30 if your loan has an annually adjusting rate or fixed rate. But if the interest rate adjusts monthly, you might pay at most $35.
- Third-party fees
Other than the fees lenders charge, third parties are also allowed to charge you fees. These include appraisal fees, home inspection fees, and recording fees.
In addition to these fees, keep in mind that the interest rates for reverse mortgages are typically higher. And, your interest rate will depend on several factors, including your lender and credit score.
Who Can Get a Reverse Mortgage?
Getting a reverse mortgage is quite an easy process, especially if you’re qualified. In this section, we’ll discuss if you can get a reverse mortgage.
Like we’ve mentioned, there’s an age requirement of 62. Aside from that, below are some of the other requirements you have to meet to get a reverse mortgage:
- You must own your home or have another property you can borrow against.
- Your home must be your primary residence.
- Your financial dues, such as property taxes, home insurance, and homeowners association dues, must be paid.
- You must attend a HUD-approved consumer information session.
- If you have an existing mortgage, you must pay off using your reverse mortgage funds.
Should You Avoid a Reverse Mortgage?
The simple answer to this question is it depends. If you know that you don’t have enough home equity, we suggest that you steer away from a reverse mortgage.
If you don’t fully understand what a reverse mortgage is, it’s probably best you consider other options. This is because reverse mortgages are quite complicated.
Additionally, if you want to leave your home as an heirloom, a reverse mortgage isn’t your best option either. This is because your heir might be required to sell the house if they can’t afford to pay your balance.
Reverse Mortgage Alternatives
Now that we’re done with reverse mortgages, you might’ve already come up with a decision. Like we’ve said, if you don’t fully understand what it is, it’s best to look for other options.
For those of you who want to unlock the home equity they’ve earned, there are other ways to do so. If you think a reverse mortgage isn’t for you, here are some alternatives we suggest you consider.
Downsizing means you’re going to have to sell your home to move into a cheaper home. You can move to an apartment, a condo, or a smaller house to unlock your equity.
However, this entails you losing your family home.
You can choose to get refinancing or a new mortgage if you don’t have an existing one. With this, you can extract your equity and cash out from it.
Through this alternative, you can extract only what you need while still getting monthly funds.
- Home Equity Loan or Home Equity Line of Credit
If the two options don’t sound useful to you, you could borrow against your home equity through a home equity loan or line of credit.
A loan enables you to get a lump-sum upfront that you can pay on an installment basis. On the other hand, a line of credit lets you borrow funds at any time, up to your credit limit.
In the end, a reverse mortgage is just like other financial tools available to you. You need to understand what it is and what it entails. Also, you have to know how it might affect your finances.
Like other financial tools, a reverse mortgage may or may not be for you. Just keep in mind that looking for options is the best way to find what’s best for your needs and situation.
Liked this article? Read the ones below to know more about mortgages:
- The Basics of Mortgage
- You Shouldn’t Miss Out on Your Mortgage Payments. Here’s Why
- Paying Your Mortgage With a Credit Card
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