Is a pile of credit card debt the only thing standing between you and the retirement of your dreams?
You might have heard a reverse mortgage could be the solution, but experts say you should think twice before signing on the dotted line.
What is a reverse mortgage? “It's essentially accessing a portion of the equity in your home and turning it into cash,” says Amy Ford, director of home equity initiatives for the National Council on Aging, adding that the loan doesn't come due until you move, sell or die.
But a reverse mortgage is only available to homeowners 62 and older, and it has a lot of special rules and some big possible pitfalls, experts say.
“When you're thinking about it with stars in your eyes, it looks wonderful,” says Norma Garcia, senior attorney and manager of the financial services program for Consumers Union. “But there are some serious issues people need to consider.”
Reverse mortgages 101
When the term reverse mortgage is used, it usually refers to the Federal Housing Administration's (FHA) Home Equity Conversion Mortgage (HECM) program. The program allows seniors who have paid off or substantially paid down their original mortgage to tap into their home equity for extra funds.
Some lenders also offer so-called proprietary reverse mortgage loans that are not HECM loans and, unlike HECM loans, are not FHA-insured. If you are looking at a proprietary loan, make sure you understand how it works because the rules might be different from those for HECM loans, according to the Consumer Financial Protection Bureau.
To get an HECM, you must get advice from a counselor approved by the U.S. Department of Housing and Urban Development. The session usually takes place over the phone, Ford says.
The counselor will make sure you meet the eligibility requirements — for example, the home must be your primary residence and you can't be delinquent on any federal debt — and give you details about how the process works.
You can get the cash in a variety of ways — for example, a lump sum at closing, monthly payments to you or a line of credit you can access when you need it, according to HUD.gov. You own your home — the bank simply is a lienholder — and you're still responsible for property taxes and maintenance, says Tony Lopes, housing director at Cambridge Credit Counseling Corp., a nonprofit credit and housing counseling agency in Massachusetts.
The loan must be paid back in full when the last borrower moves out of the home or dies, according to the CFPB. Heirs can either pay back the loan from their own funds and keep the home, or sell the house to repay the loan. If the amount owed is more than the house is worth, mortgage insurance covers that gap.
Reverse mortgage pluses and minuses
One big benefit: Reverse mortgages are very flexible, Ford says. For example, she says, you can use the money for anything you want — from paying off debt, to making ends meet, to a dream vacation to home improvements.
But one major downside is that reverse mortgages are very expensive, Ford says. Costs typically include:
- An appraisal fee that averages $450, according to the National Reverse Mortgage Lenders Association.
- A mortgage insurance premium (MIP) that is due at closing and can range from 0.5 to 2.5 percent of the value of the home, depending on what percentage of available funds you take in the first year.
- Servicing fees.
- Closing costs.
- Interest that is compounded, meaning it is added to the principal.
“A reverse mortgage is, without a doubt, higher cost than a regular mortgage,” Lopes says.
Another problem: If you have to leave your home for health problems or other reasons, the loan will come due, Lopes says.
“I've had people say, 'If I had known what I was getting into, I wouldn't have done it,'” Garcia says.
Reverse mortgage advice for consumers
Are you considering a reverse mortgage? If so, here are five tips from experts:
- See if programs can help you avoid a reverse mortgage. Budget shortfall? You might qualify for a federal or state benefits program instead, Ford says. You can visit BenefitsCheckUp.org to see if you can get help for food, medications or other necessities.
- Get professional advice. Meet with a professional — such as a financial planner, an elder law attorney or a certified public accountant — who has no connection to the reverse mortgage business, Garcia recommends. The short counseling session required by HUD isn't enough, she says: “The chances of a consumer not getting the individual attention they need to make a decision [are] high.”
- Explore other debt repayment options. A reverse mortgage might not be the best option to pay down credit card debt. “If a person can afford to pay down debt through some other means, that's going to be a better solution,” Lopes says. One possibility: Discuss a debt management plan with a credit counseling agency, he recommends. Selling assets might be another option, Garcia says.
- Talk to family members. Some homeowners don't want to tell their adult children about their plans to get a reverse mortgage, but openness can prevent surprises in the future and even open up other options, Garcia says. She adds that a number of adult children have told her they would have been willing to help their parent financially to avoid a reverse mortgage. One option to consider: an inter-family reverse mortgage, Garcia says. You can have an elder law attorney draft an agreement that resembles a reverse mortgage, but with the loan coming from family, she says.
- Be smart about how you take the money. One big mistake some consumers make is taking a lump sum upfront rather than drawing on the home equity when they need the cash, Garcia says. That's because the homeowners are not making payments on the loan, and the compounded interest quickly accrues. “The amount you owe to pay it off might be much more than you can imagine,” she says.
On the other hand, if you get a line of credit and take money as needed, you only pay interest on the amount you have withdrawn. And, your line of credit grows over time, Lopes says. “The growth can be a pretty substantial amount,” he says. For example, if you start off with a $100,000 credit line, it might grow to $105,000 in a year, he says. “That can be a good use of a reverse mortgage.”
And finally, make sure you fully understand how a reverse mortgage works before you get one. Garcia says: “People think, 'I've had a mortgage before, so I know how it works,' but this is a mortgage of a different stripe.”