Are they too good to be true?
The ads for reverse mortgages, aka Home Equity Conversion Mortgages (HECM), tout them as a way for older people to take the equity out of their homes so they have money to spend on other things they want or need. They’ve been effective — more than 1 million reverse mortgages have been sold since introduced in 1990. In one ad, Tom Selleck, a celebrity who is credible among older folks, begins by saying, “I know what you’re thinking. Some things are too good to be true.”
I’ve always been skeptical of such products. As my initial impression, based only on the most cursory information, they’re just another way for financial companies to take advantage of people who are not money-savvy and are possibly facing difficult times. In other words, perfect marks for a con.
So I decided to look into whether they are indeed too good to be true. Here’s what I’ve learned…
Let’s begin by describing how they work. As I said, you borrow money against your home — your home is the loan’s collateral. You can borrow as much as you like up to the amount of equity you have in your home. Well, almost — the amount you can actually borrow is based on a formula that includes the value of your home, but also your age and prevailing interest rates.
To qualify, you have to be 62 or older, and, of course, own a home. You can’t be delinquent on any federal debt, you must live in your home, and you must demonstrate that you can pay taxes, insurance, and other ongoing expenses, such as repairs. The property must also meet all FHA standards and flood requirements. You can get a reverse mortgage if you also have a conventional mortgage, but you must use the money to pay off that mortgage.
It’s not like a conventional loan where you borrow money and pay off the principal and interest over time. For a reverse mortgage, you don’t make any payments, and the loan is paid off when you either sell your home or die, whichever comes first. But make no mistake it is a loan, and it will have to be paid back at some point, either with cash or with the house.
And even though you don’t make any monthly payments, you can default on a reverse mortgage. That can happen if you don’t pay your property taxes or homeowner’s insurance, or if the property falls into disrepair, or move out.
Once you’re approved, you can receive the funds as a lump sum, a line of credit, or as income over the course of your lifetime or over a specified period of time. The loans are available in adjustable and fixed interest rates, but if you choose a fixed rate, you will be required to take a lump-sum payment.
That’s the general idea. Here are the advantages…
- You can use the money however you like.
- You can live in your home as long as you like. As long as you your property taxes and insurance, you can’t be evicted.
- You retain the title, and because it stays in your estate, when you die you can pass on whatever equity is left after the loan is paid back.
- They’re easier to qualify for than a conventional home equity loan because there are no income or credit score requirements.
- You’re not responsible if your home loses value — if the price of the house drops below the amount of the loan, the lender takes the loss.
- Reverse mortgages are insured by the FHA, so you still get your money even if the lending company goes out of business.
Sounds good so far, but there are downsides…
- There are hefty upfront expenses, such as application fees and closing costs. These are bundled into the loan so you don’t have out-of-pocket costs, but still they are steep. For example, there is a 2% mortgage insurance premium (MIP) on the home value. So, if you own a $400,000 home, the upfront MIP would be $8,000, regardless of whether your loan is for $30,000 or $200,000.
- Interest rates are higher versus home equity lines of credit and second mortgages.
- You will cut into the equity of your home, which means less money to your heirs. And they can’t inherit the house unless they pay back the loan.
- Don’t plan on leaving any time soon. If for whatever reason you want to sell your home, you first have to repay the loan.
- And don’t do it too young. While you become eligible at 62, you might use up the money if you live longer than you expected, or could afford to.
- These loans can affect your eligibility for programs like Medicaid and Supplemental Security. For example, eligibility for Medicaid depends on your total assets. While you may be able to exclude your home’s value, there are limits on the size of your bank account. If the cash you get from a reverse mortgage sits in your bank, that may put you over the threshold.
- You need a substantial amount of equity in your home. If you already have a big mortgage, you won’t get much out of a reverse mortgage.
You have to judge for yourself, based on your own needs, whether a reverse mortgage makes sense for you. But it seems that, if you’re credit is good and you need cash, you can get a home equity loan or a second mortgage at a much better price.
And if that doesn’t cut it for you, consider selling your home and downsizing to a smaller place, or renting. Oftentimes the money you get for your home, when invested, will provide enough income to pay rent — so it’s a break even, and you don’t have the upkeep to worry about.
