Reverse Mortgages: Stay Home, Make Money
What good is a real estate boom if you don't want to sell your house? With a reverse mortgage, seniors can cash out without moving out.
(MONEY Magazine) - As real estate prices in large parts of the country have more than doubled during the past five years, homeowners have found plenty of ways to cash in on their new riches.
Many are trading up to an even bigger house or borrowing against their bloated equity to remodel the kitchen, buy a vacation home or consolidate debts.
But for one group, these paper riches are just that. If you're retired with no plans to downsize and no desire to add loan payments to your budget, how can you benefit from your real estate wealth?
Enter the reverse mortgage -- a loan that lets homeowners age 62 and older take money out of their home and never have to move out or worry about paying it back.
Think of a reverse mortgage as the mirror image of a traditional mortgage. When you borrow to buy a house, your monthly payments whittle away at your debt and build up your equity over time.
With a reverse mortgage, you gradually take that equity out and increase your home's debt. The bank doesn't collect the principal and interest until you or your heirs sell.
Although reverse mortgages still represent only a small fraction of home loans, demand for these once obscure financial products has grown exponentially. Last year more than 43,000 homeowners took out a reverse mortgage. In 1990 about 150 did.
"We used to joke that more stories were written about reverse mortgages than loans originated," says Bronwyn Belling, a reverse mortgage specialist for the AARP Foundation.
Today real-estate-rich retirees are taking out reverse mortgages to pump up their income, fund home improvements or refinance debts. Still, these loans are not without serious drawbacks -- complexity and high costs among them.
You can find lots of reasons to take out a reverse mortgage, and many others to walk away. Here's how to sort out your choices.
Why Go in Reverse?
With a reverse mortgage, it's possible to withdraw roughly half the value of your home.
A 70-year-old owner of a $200,000 house, for example, could take out $113,000 at today's rates or opt for a $700 monthly payment for life. You don't need good credit, a high income or ample savings to qualify.
How much you can borrow comes down to four factors: the value of your house, where you live, current interest rates and your age. (Younger homeowners qualify for smaller loans because a longer life span means more years for interest to accrue -- and more risk that the bank will lose money.) For an estimate of what size loan you could qualify for, go to reversevision.com.
Consider the loan for these three goals.
MONTHLY INCOME A reverse mortgage means a regular check to supplement your pension, investments or Social Security -- a small one for life or a bigger one for just a few years. When Lee and Mary Foreman, now 65 and 64, retired to Coppell, Texas six years ago, they paid cash for their house and planned to live off their stock and bond portfolio. "Then the economy tanked and our projections for our retirement savings didn't pan out as we thought," says Lee, who worked in commercial real estate before retiring.
Rather than sell their depressed investments, the couple took out a reverse mortgage that pays them a fixed monthly sum for five years and left their portfolio alone to recover. They'll begin tapping their individual retirement accounts only when they have to, after age 70. "We look at our reverse mortgage as a financial planning tool," says Lee. Similarly, you might consider drawing down your home equity early in retirement so that you can put off taking a pension or Social Security and collect richer payments when you do.
A CREDIT LINE The most popular and potentially least expensive way to take out a reverse mortgage is through a line of credit. You pay interest only on the money you withdraw, and the amount you can tap in the future keeps growing as you age.
Retired college football coach DeWayne King and his wife Peggy own their house in Waukesha, Wis. outright but needed help paying for some home improvement projects. In September they closed on a reverse mortgage, which they access via a line of credit. So far they've put in a lift to help Peggy, 77, get up and down stairs, and they've replaced their carpeting. "We have every intention of staying put in this house," says DeWayne, 80.
DEBT MANAGEMENT If you bought a home late in life or had to dip into home equity to fund big expenses like college tuition, you could very well find yourself still paying off a mortgage deep into retirement. Refinancing into a reverse mortgage can erase that monthly payment.
When Barbara and Frederick Mele found they were struggling to make their $900 monthly mortgage payments--as well as pay the rest of their bills--with their pensions and Social Security, they considered selling their three-bedroom Lawrence, Mass. house.
But as Barbara, 70, notes, "We've lived in the house for 35 years, and it's just perfect." Instead, Frederick, 73, and Barbara got a $260,000 reverse mortgage, using $130,000 to pay off their existing mortgage and $20,000 to pay off their credit cards. They'll keep the remaining $110,000 as a line of credit.
Why Think Twice?
While there are many benefits to putting your mortgage in reverse, there are two big reasons not to.
THE PRICE TAG You could be charged as much as $10,000 to take out a $200,000 reverse mortgage after you cover the 2% lender's origination fee, 2% mandatory mortgage insurance and miscellaneous costs such as title insurance, an appraisal and even repairs. You'll also owe 0.5% of the loan balance in mortgage insurance premiums every year.
When Henry Clark, 86, learned that he'd have to pay $8,000 for a $50,000 reverse mortgage on his Haw River, N.C. house, he decided to skip the loan. "I had an idea of buying a new car and traveling with my wife," he says, "but now I guess I'll keep my 2000 Buick LeSabre and travel less."
You may consider these fees a small price to pay for the ability to hold on to your home and preserve your standard of living. (And the costs may not seem so bad compared with the 5% to 6% brokerage commission you'd have to pay if you sold your house.)
But if you think you may downsize in a couple of years anyway or will need to move to an assisted-living facility, a reverse mortgage probably isn't your best option for cash, says Barbara Stucki, project manager of the National Council on the Aging's reverse mortgage initiative.
"Because these loans have sizable up-front costs," she says, "your time frame is critical." Instead, consider a cash-out refinancing or home-equity loan to tide you over until you sell.
THE FUTURE Someday your mortgage has to be paid off, either in cash or when the house is sold. Although mortgage insurance ensures that you or your heirs won't owe more than your house is worth, it's entirely possible to drain your home's equity, leaving your children with little or nothing.
One reason is that when the loan comes due, the bill is for what you borrowed plus fees and interest, and rates on reverse mortgages are not fixed. The annual rate, recently 8.3%, is the rate on a one-year Treasury bill plus 3.1 percentage points and 0.5 points for insurance. Over the life of the loan, your rate can't rise more than five points. At today's rate, a homeowner who borrows $100,000 would owe $222,000 in interest and principal in 10 years.
If leaving your home or money to the next generation is important, think twice. "I recommend talking to your children before your go through with a reverse mortgage," says Patricia Houlihan, a certified financial planner in Reston, Va. Another option for cash is to sell the house to your children and rent it back.
How to Shop for a Loan
If you decide a reverse mortgage is right for you, you have still more decisions to make, including what loan program to use. The U.S. Department of Housing and Urban Development's home-equity conversion mortgage (HECM) is the only reverse mortgage insured by the federal government, but loan values are capped based on typical home prices in your area. If you own a valuable house, you may be better off with a loan from Fannie Mae or from a private lender such as Financial Freedom (financialfreedom.com).
When you shop, you have one thing going for you: Because reverse mortgages are so confusing, you have to meet with a counselor before you can apply. That person will spell out the pros and cons, as well as the alternatives.
To find a counselor and learn more about these loans, contact the AARP Foundation's Reverse Mortgage Education Project (800-209-8085; aarp.org/revmort). When choosing a lender, stick with specialists affiliated with the National Reverse Mortgage Lenders Association (reversemortgage.org).
Counseling means that closing on your reverse mortgage could take up to three months, but considering that this loan could provide financial security for a lifetime, it's worth the wait.
If your children want to keep your home after you die, they'll have to fork over money to the bank.