A reverse mortgage is one where an older Northwood home owner borrows from the equity of the home. It's typically popular for people with a solid stake in their property who need funds for retirement, education, or unexpected emergencies. While this can be a great option for some people, there are a lot of reasons not to give ownership to a lender. Learn more about the pros and cons of this option and whether it makes financial sense.
To take out a reverse mortgage, lenders will check off the following criteria:
- Homeowners cannot have any unpaid federal debt.
- All homeowners must be 62 or older.
- Sufficient equity (typically at least 50%).
- Reverse mortgage is only being used for the primary property (i.e., not for a vacation home).
- Homeowners have sufficient income to pay for average household expenses.
- Homeowners agree to take consumer counseling training before taking out a reverse mortgage.
Lenders and the Reverse Mortgage
In a reverse mortgage, the lender is under contractual obligation to pay the lender rather than the other way around. This not only decreases the amount of equity in the home, but it also increases the amount of money still left on the home loan. As with the original loan package, lenders are allowed to set terms for the borrower based on interest rates, property value, and the state of the market. Homeowners will need to read the fine print to understand how much they'll pay over time.
Interest rates were historically prohibitive for owners looking to capitalize on reverse mortgages, but this has changed in the recent past. In some areas of the country, a reverse mortgage can be a reasonable way to finance expenses without having to take out a conventional loan.
Do Owners Have to Qualify Their Purchases?
The short answer is no: if an owner takes out a reverse mortgage, they can use the money to do anything they wish. This is good news for those who may want to do some traveling in their golden years or pay off medical bills. Even better, the loan is typically only paid back once the owner passes away or the property is sold to a new buyer. If homeowners sell the home, they're allowed to keep any leftover funds once they finish off paying the cost of the loan. If the situation is reversed, the descendants of the owners will not be required to pay for any excess funds left on the loan.
The Drawbacks of a Reverse Mortgage
The biggest drawback of a reverse mortgage is that a homeowner will inevitably compromise the value of their estate. If the rates are high enough, homeowners could lose any stake they once had in their home. It means there's less to pass on to future generations who might have appreciated keeping the legacy alive. (Still, for those who see a more immediate need, such as their grandchildren's education, this sacrifice can be well worth it.) If the children do want to keep the home, they're responsible for paying back the compromised loan.
The other major drawback is the interest rates. If the market falls and the home sells for far less than it was originally worth at the time of the reverse mortgage, then lenders will have to absorb that loss. To mitigate that potential outcome, the rates are usually set high enough that homeowners should be extra cautious. So while rates may be historically low at the time of signing up, they may still prove too high to be sensible.
Calculating the cost of the mortgage over the span of several years (or even several decades) may be difficult to do. However, it's the best way to figure out if the fees and interest rates actually make the reverse mortgage worth the risk. Most lenders will bundle all these costs together and combine them with equity. (This way, buyers aren't required to pay for the fees and interest with the money they're getting from the lender.)
Some financial experts recommend High Equity Conversion Mortgages instead of a standard reverse mortgage to avoid the higher rates. This reverse mortgage is sponsored through the Federal Housing Administration (FHA) and is different than the standard FHA loan. This way, lenders don't feel the need to hike up their interest to avoid a potential loss.
Finally, homeowners need to think about the everyday costs of owning a home. They may be receiving money every month, but they'll still need to pay for property taxes, homeowner's insurance, and standard upkeep costs. If the owner can't pay these costs, they may be required to pay back the reverse mortgage.
Talking to a financial expert or real estate agent about the pros and cons of a reverse mortgage can be a smart way to avoid making the wrong move. As mentioned, the interest rates and fees can be difficult to spot without a background in lending.