Dear Senior Living Adviser,
My wife and I are both in our late 60s and retired. While we don't have an extravagant lifestyle, it's hard making ends meet, much less to do the things we want to do in retirement.
I see all these ads for reverse mortgages and wonder if that's the best solution or if we'd be better off with either a cash-out conventional mortgage or a home equity loan. What do you think?
-- Artie Amortization
A reverse mortgage -- which is known as a home equity conversion mortgage, or HECM -- when it is part of the Federal Housing Administration's reverse mortgage program, is not a decision to enter into lightly.
The Consumer Financial Protection Bureau has done a study on the reverse mortgage ads and found that they confuse seniors more than they help them. That may be true, but part of the reverse mortgage application process is mandatory counseling so the borrowers have a better understanding of the loan and its terms.
Just as they say in the ads, you still own your home. What they don't say is that you're still responsible for the taxes, homeowners insurance, flood insurance and any homeowners association fees.
Reverse mortgage vs. conventional mortgage
Seniors often struggle to qualify for a cash-out conventional mortgage or even a home equity loan because, regardless of how much equity they have in their home or the value of their other investments, they don't have sufficient income to qualify for the 1st or 2nd mortgage loan.
Aside from the struggle in qualifying for these mortgages, you've got to make the monthly mortgage payment. A home equity line of credit (HELOC) trumps the cash-out refinancing because you aren't borrowing a lump sum up front, and in the early years of the HELOC, the payments are interest only. A HELOC typically will have much lower closing costs than a cash-out first mortgage or a reverse mortgage. Still, you're trying to stretch your retirement income and adding a monthly mortgage payment works against that goal.
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The key advantage of the HECM is that you don't have to make a monthly mortgage payment. The interest expense is capitalized, meaning that it's added to the loan balance. With a conventional mortgage, the monthly payments are high enough to pay the interest expense and pay off the loan over the loan term.
When a HECM comes due
With a reverse mortgage, the loan term isn't fixed and you see the loan balance increase over time. The HECM comes due when a qualifying event happens, typically after the last borrower on the loan dies or 12 months after the last borrower moves out of the home.
With a fixed-rate HECM, you get a lump-sum payment when you close on the reverse mortgage.
With an adjustable rate HECM, you have 5 options in how you tap your home's equity. As presented on the FHA Reverse Mortgages (HECMs) for Seniors' website, they are:
- Tenure: With equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.
- Term: With equal monthly payments for a fixed period of selected months.
- Line of credit: With unscheduled payments or installments, at times and in an amount of your choosing, until the line of credit is exhausted.
- Modified tenure: With a combination of line of credit and scheduled monthly payments for as long as you remain in the home.
- Modified term: With a combination of line of credit plus monthly payments for a fixed period of months selected by the borrower.
With HECM loans, the borrower pays a mortgage insurance premium, closing costs and a servicing fee. This type of loan is more expensive than a conventional cash-out mortgage, and much more expensive than a HELOC. The big attraction is that you don't have the monthly mortgage payment.
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Consider long-term care
Another consideration is long-term care. If you plan on using Medicaid for long-term care, having a lump sum from your HECM sitting in the bank will delay when you can qualify for Medicaid.
Consult with a certified elder law attorney before getting a lump sum from an HECM if you think Medicaid is in your future.
Keep in mind that the odds are good that at least one of you will make it to your 90s. Don't buy into a lifestyle in your 60s that spends out the financial backstop you have in your home's equity for wants like travel and the grandchildren's tuition.
Focus on whether a reverse mortgage is the best way to meet your retirement income needs. If you spend like there's no tomorrow, what happens when tomorrow comes?
Ask the adviser
To ask a question of Dr. Don, go to the "Ask the Experts" page and select one of these topics: "Senior Living," "Financing a home," "Saving & Investing" or "Money." Read more Dr. Don columns for additional personal finance advice.