Homeowners tired of being house rich and cash poor have an interesting option when they reach age 62: a reverse mortgage that allows them to pay off their home loan and no longer make monthly mortgage payments.
Without a reverse mortgage, they may still own their homes outright someday by paying off their mortgage, and can enjoy the benefits of no longer making loan payments. But their equity will still be tied up in their house, and they won’t be able to use the cash that a reverse mortgage allows for other expenses, such as medical costs and other needs in retirement.
“You have equity, but that equity is in the form of bricks, drywall and whatever else your home is made of,” says Kyle Winkfield, managing partner of O.W.R.S., financial advisors in Rockville, MD.
“Your equity is not dollars. It’s illiquid,” Winkfield says.
Basics of a reverse mortgage
The most popular reverse mortgage is a Home Equity Conversion Mortgage, or HECM. They’re government-insured (FHA) and use the borrower’s home as collateral. A HECM is a loan that is repaid with interest when the borrower dies or moves.
Common misconceptions about reverse mortgages are that borrowers are giving up their asset and increased home value, and are giving up their inheritance, says Mary Catchur, president of Marimark Mortgage in Tampa, Fla.
If the borrower dies, then the home is sold and their heirs would get any money left after the loan is paid off.
Privately sponsored reverse mortgages have higher costs than ones backed by the FHA (Federal Housing Administration) and FHA reverse mortgages typically have lower interest rates.
Along with no longer having monthly loan payments, borrowers can take out loans against their home equity as a monthly payment, lump sum or line of credit for up to 57.5 percent of their equity.
“The reverse mortgage can create additional financial security by providing additional liquidity,” Winkfield says. "You can sit on the line of credit until you need it."
You can also use a reverse mortgage to buy a second home, such as a vacation home. The money can be spent however the borrower wants to, but should be used cautiously, he recommends.
But for some people, a reverse mortgage can help financially strapped people afford to stay in their homes and not rely on family members for financial assistance, Catchur says.
“For somebody who is age 62 or older and has a good amount of equity in their home, using a reverse mortgage to pay off the existing mortgage can be a tremendous benefit,” Catchur says.
“Many elderly people are living on tight budgets, trying to live on limited Social Security and other retirement funds, while having to pay for costly medications and upkeep of their home,” she says.
Use with caution
Tapping the biggest asset that they’ve paid into for 20-40 years and have plenty of equity in comes with some notes of caution for homeowners.
By freeing up cash that was being used to pay a traditional mortgage, a reverse mortgage can look like a windfall. Instead, it should be used as a tool to plan your financial future, Winkfield says.
“In the end, my approach is always to to approach reverse mortgages cautiously and within the framework of a detailed and well thought out retirement income plan,” he says.
“Consumers cause unnecessary strife when they buy and execute a great idea or financial product without thinking through the impact to their overall financial plan and goals,” Winkfield says. “Reverse mortgages are a great financial tool when used correctly.”
Reverse mortgages backed by the FHA require counseling with housing officials. A family member must accompany the borrower to ensure they understand how the program works.
Reverse mortgage examples
Borrowers must be at least 62 years old. The amount that can be borrowed against the equity is based on life expectancy, Catchur says.
The owner of a home valued at $250,000 with $40,000 remaining on the lien would be eligible to borrow up to $79,445 through a line of credit if they were 62 years old, according to a scenario Catchur presented. If they were 72, the loan limit is a $96,195 — a much bigger line of credit.
To give an idea of the costs of the reverse mortgage for the 72-year-old in the above scenario, the closing costs would be $11,554, which are rolled into the reverse mortgage and due when the owner dies or sells the home. They would keep $102,250 of the home’s value in equity reserves.
Reverse mortgages require the homeowner to continue paying property taxes and insurance on the home, which are part of new reverse mortgage rules added two years ago to protect seniors from themselves. If they can’t afford to pay such basic expenses from methods outside of a reverse mortgage, then they won’t qualify.
Being house rich and cash poor doesn’t have to part of life after age 62. A reverse mortgage is one option to take advantage of what may be your biggest asset.
But there are other options that should be discussed with a financial planner. They include refinancing an existing mortgage, taking out a home equity loan or home equity line of credit, or selling your home and downsizing.
Another option is to sell your home to your children with a sales-leaseback agreement where you rent it back by using cash from the sale. Your children are your landlords and earn rental income while being able to deduct real estate taxes, maintenance and other costs.
However you decide to help fund retirement, be sure to research the best rates and programs, and consult a lawyer, tax consultant and financial advisor to get advice on if a reverse mortgage or another option is best for you.