A reverse mortgage is a home equity loan for older homeowners. It does not require monthly payments and instead lets the borrower convert a portion of the equity into cash. Equity may be paid out monthly for a fixed period, or as a lump sum, or as a line of credit.
Pros and cons of a reverse mortgage
- Does not require monthly payments from the borrower.
- Proceeds can be used to pay off debt or settle unexpected expenses.
- The money can pay off the existing mortgage.
- Funds can improve monthly cash flow.
- Fees and other closing costs can be high.
- Borrower must maintain the house and pay property taxes and homeowners insurance.
- A reverse mortgage can complicate one's wish to keep the house in the family.
Regulations protect reverse mortgage borrowers, but it's still up to them to know exactly what they are getting into when they take out a reverse mortgage, says Steven Sass, program director at the Center for Retirement Research at Boston College.
A reverse mortgage makes sense under certain circumstances, says Bruce McClary, a spokesman for Washington, D.C.-based nonprofit financial counseling service National Foundation for Credit Counseling. "Not all offers are the same. Seniors need to look at the details and ask a lot of questions."
Know the costs
Reverse loans charge mortgage fees and other closing costs. The borrower must maintain the house and pay property taxes and homeowners insurance. Borrowers are given a reverse mortgage financial assessment to determine whether they can pay those costs.
Age and equity count
Homeowners must be 62 or older to take advantage of a reverse mortgage, and they have to occupy the property as their primary residence.
There has to be enough equity in the home to tap. To qualify for a reverse mortgage, you should have at least 40% equity, according to Gregg Smith, president and chief operating officer of One Reverse Mortgage, the San Diego-based reverse mortgage unit of Detroit-based Quicken Loans.
If there's an existing mortgage, you also must have enough equity to pay it off, says Peter Bell, president and CEO of the National Reverse Mortgage Lenders Association, the Washington, D.C., trade association.
Who would benefit
According to Sass of the Center for Retirement Research, a reverse mortgage makes sense for people who don't plan to move, can afford the cost of maintaining their home and want to access the equity in their home to supplement their income or have money available for a rainy day.
Bell says some people even use a reverse mortgage to eliminate their existing mortgage and improve their monthly cash flow.
"There are a lot of motivations leading into it," Bell says. "In some cases, people may have an immediate need to pay off debt, or they may have had some unexpected expenses like a home repair or health care situation."
Who wouldn't benefit
A reverse mortgage wouldn't be the best option if you can't maintain the costs associated with the home, even without a monthly mortgage payment.
If you die or the home isn't the primary residence for more than 12 months, the loan comes due, which means either you or the estate has the option to repay the loan or put the home up for sale to settle it.
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