retirement

Basics of reverse mortgages

There are no restrictions for how the money from a reverse mortgage loan must be used.

Many people in retirement use it to supplement their income, pay for health care expenses, pay off debt or pay for home improvement jobs.

Retirees can collect their payments on a reverse mortgage as a lump sum, fixed monthly payment, line of credit or some combination.

The downside

However, before you rush out to apply, there are some serious drawbacks to consider.

"Reverse mortgages are a wonderful tool to have at your disposal, but you should only play that card if you're out of other options," says Phil Cook, a Certified Financial Planner in Manhattan Beach, California.

Downside of reverse mortgages

  • May affect benefit eligibility.
  • Higher-than-average closing costs and interest rate.
  • May diminish value of estate.

For starters, reverse mortgages are complex and costly -- and may affect eligibility for Medicaid and Supplemental Security Income benefits.

As a result, homeowners interested in taking out a reverse mortgage are required to receive mandatory (free) counseling by an independent third-party, including an agency approved by the Department of Housing and Urban Development or a national counseling agency such as AARP. These organizations help homeowners review alternative options.

"As you get older, it gets harder to grasp some of the terms in these kinds of transactions, so it's not a bad idea to have someone younger who you trust, like an adult child, involved in the process," says Cook.

If you decide to proceed with the loan, you can expect to pay higher-than-average closing costs based on the value of your home, including origination fees, upfront mortgage insurance and appraisal fees.

The interest rate you pay is also generally higher than that for a traditional mortgage.

Keep in mind that anyone who takes out a reverse mortgage loan remains responsible for paying property taxes, insurance and repairs on their home. If you fail to comply, you may be required to repay your reverse mortgage early.

Spending the equity in your home, of course, also diminishes the value of your estate -- leaving you less to pass along to your heirs down the road.

"Always explore all other sources of income first before tapping into your home equity," advises Cook. "Liquidate your portfolio and cut down on your living expenses. If you still don't have enough, a reverse mortgage may make sense."

To locate a Federal Housing Authority-approved lender or HUD-approved counseling agency, you can visit HUD's online locator or call the Multifamily Housing Clearinghouse at 1-800-569-4287.

NRMLA also maintains a database at ReverseMortgage.org.

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