Let your home pay you
Reverse mortgages gain in popularity for older owners
By Jennifer Openshaw
Reverse mortgages are expected to explode in the coming years. According to the National Reverse Mortgage Loan Association (NRMLA), nearly 38,000 reverse mortgages were originated in 2004, up from just over 18,000 in 2003. They’re expected to grow a whopping 58% this year to more than 60,000 originations.
Most people are familiar with traditional (sometimes called forward) mortgages. In exchange for signing a stack of papers as thick as a NYC phone book, a mortgage lender will let you buy a house on credit as your agree to pay them back every month for the next 15-30 years.
A reverse mortgage, however, is almost the complete opposite. In return for a mortgage on the property, the homeowner receives a loan that can be paid to them in a lump sum, as a stream of monthly payments or even as an available line of credit to be tapped when needed.
No loan payments are required while the reverse mortgage is outstanding. The loan is repaid when you cease to occupy the home as your principal residence, when you sell the home or when you die.
What’s suddenly driving the expected surge in reverse mortgages in coming years? Top on the list is our aging society. With the first wave of baby boomers turning 60 this year, look for reverse mortgages to become a viable option to those who are cash-poor, but house-rich in the coming years. Having the option to stay in your own home while converting the unused equity into a new monthly income stream can be appealing to retirees.
In addition, those who live very long lives can find themselves in the position of having exhausted their financial resources (and sometimes health insurance) but having paid off their house. Combine this with the runaway growth in home values in many parts of the nation and you have a situation ripe for tapping unused but needed home equity.
Most retirees have lived in the same house for many years and do not want to leave the comforts of that home, their local friends, favorite vendors, etc. And staying in your own home saves on the double closing costs of buying and selling a home, as well as the dilemma of having to replace a home in an inflated real estate market.
Old enough and good enough to qualify?
Partly because these products are targeted at older individuals, laws have been put into place to control reverse mortgages and protect consumers. Among these rules are:
- The age of the youngest person on the title to the home must be at least 62.
- Eligible properties include single-family homes, manufactured homes built after 1976, qualified condominiums and townhouses.
- The interest rate is the same no matter which lender is chosen.
- Counseling from an independent network of reverse-mortgage experts is required.
- No time limit exists on the term of the reverse mortgage — except that it cannot become due during the homeowner’s lifetime.
- The loan amount cannot exceed what the home is worth at any time during the loan.
In large part due to these rules, proponents of reverse mortgages cite the following advantages:
- Receive tax-free income without having to sell your home
- No income or asset minimums to qualify
- No restrictions on what the proceeds can be used for
- No monthly payments while the loan is outstanding
Don’t jump into reverse
If this is starting to sound too good to be true, it is important to review the disadvantages of reverse mortgages. The first? Expenses.
In addition to normal closing costs, government-insured reverse mortgages also tack on a 2% fee for FHA insurance designed to protect against the home value slipping below the loan value. A one-half percent annual cost is also added for this insurance each year the reverse mortgage is outstanding.
With these hefty costs, reverse mortgages are not for those who need a smaller amount of money (try a home-equity line of credit for those) or for those who may decide to move from the house in a few years.
Also, the location of the house affects the loan size. For 2005, the FHA loan limits are $172,632 for homes in rural areas and up to $312,896 for homes in large urban areas. Borrowers should make sure they have other adequate cash flow since the lender can require immediate prepayment if you declare bankruptcy, fail to pay your property taxes or insurance, or even fail to keep the home in good repair.
Finally, don’t forget that a cash-poor person who spends their home equity on travel and fancy cars might have just whittled away the only emergency fund in reach in the event of a health care or other financial disaster.
Heirs don’t lose out
One of the biggest myths about reverse mortgages is the notion that any equity in the home is lost to heirs if the owner dies. The truth is that if the borrower dies, the heirs have up to one year to sell the house. The proceeds are first used to pay off the existing principle and interest, and any remaining dollars go to the heirs or the estate.
A recent study by the National Council on the Aging estimates that more than 13.2 million households are candidates for a reverse mortgage, and that $953 billion would be available.
Jennifer Openshaw is CEO of Family Financial Network, a national provider of financial planning and advice to families and individuals. She is the author of “What’s Your Net Worth?” and the host of a public television show of the same name. Reach her at jennifer@familyfn.com.
