For many retirees, a reverse mortgage is a good way to use what is often their most valuable asset -- their home -- to gain much-needed income later in life. A reverse mortgage allows folks 62 and older to draw upon home equity in order to receive a chunk of money or monthly income, without having to pay back the loan until they die, move, or sell the home. The money can be used for anything -- perhaps travel, long-term care insurance, in-home medical care, or home maintenance.
Here's the lowdown on reverse mortgages: what they are, how much you can borrow, and who is a good candidate for one.
How Does a Reverse Mortgage Work?
In a reverse mortgage or home-equity conversion mortgage (HECM), you trade some or all of the equity in your home in return for tax-free income from a bank or other lender. The lender's payments may be in the form of cash (a lump sum), monthly payments, or a line of credit you can draw on as needed, or any combination of these options. Most reverse mortgages are adjustable-rate products. However, lenders are beginning to develop fixed-rate and larger-denomination loans.
The loan doesn't have to be repaid until you die (or sell the home or move out). After any of these occurrences, the lender is repaid with interest. Whatever is left over goes to you or your heirs. If your total withdrawals end up exceeding the value of your home when it's sold, no need to shed tears for the lender; it will probably be protected against loss by Federal Housing Authority (FHA) insurance. (Note: One common misconception about FHA-insured reverse mortgages is that the government owns your home -- not true!)
Who Can Get a Reverse Mortgage?
Reverse mortgages are available to any homeowner over the age of 62 whose mortgage is completely or nearly paid off. If the home is jointly owned, both owners must be at least 62. Many reverse mortgages don't require a credit or income test. However, some states do require financial counseling.
How Much Can You Borrow?
The amount you can borrow is based on your home's value, current interest rates, and your age. Also, there are limits to how much of your home's value you can draw out.
Total limit. The total amount you can borrow is about 80% of your equity interest, up to a maximum amount determined by the Department of Housing and Urban Development ($625,500 in 2009). If the value of your home increases over time, the amount you'll be able to draw against will also increase until you reach the cap.
Annual limits. The government also sets annual upper limits on your borrowing based on where you live. Check with a local lender to learn the limits in your area.
Are You a Good Candidate for a Reverse Mortgage?
To determine if you are a good candidate for a reverse mortgage, consider the following:
How long will you live in the house? closing costs on reverse mortgages tend to be high. Fees for reverse mortgages are based on the value of your home or the limit on federally insured reverse mortgages in your area. Once title searches, appraisals, and other expenses are included, closing costs can exceed 5% of the home's value. So, if you plan to move in a year or two (an that event would terminate the reverse mortgage), it doesn't make financial sense to get a reverse mortgage.
Are you retired with a low income and a valuable house? Reverse mortgages are worthwhile for retirees whose incomes are low but whose houses are valuable.
Consider Edna, age 78, who owns her house outright. The house is worth about $500,000, but Edna's savings are almost exhausted and her Social Security income barely pays enough to cover her personal expenses -- with nothing left over to cover the costs of maintaining and insuring her house. Edna gets a reverse mortgage. She immediately borrows $10,000 so that she can replace her deteriorating roof, and then arranges to receive a payment of $1,000 per month. Even allowing for loan costs and interest, and assuming Edna lives into her mid-90s, she will not come close to exhausting her $500,000 in equity. Her equity may even increase if the value of her house goes up faster than the amount of her modest withdrawals.
How to Shop for a Reverse Mortgage
For a list of lenders that offer reverse mortgages and help in determining which one is best for you, check www.aarp.org/revmort. Another good website to check is www.fanniemae.com. Enter "reverse mortgage" in the home page search box to find a long list of relevant articles.
To learn more about planning for retirement to make the best of your golden years, get Retire Happy, by Richard Stim and Ralph Warner (Nolo).