Coming to the end of a mortgage loan is a milestone for many people. This often leaves them with a considerable asset but no way of accessing it unless they sell their property and move to a smaller home. For many, a reverse mortgage may be a viable solution. How do these products work and what are the pros and cons of this kind of home equity conversion?
What is a Reverse Mortgage?
This financial product is available to individuals aged over 62 who own their own homes. The aim here is to allow the homeowner to acquire cash funding from a reverse mortgage product that turns part of their property into a cash payment. So, instead of making mortgage payments, they will have payments made to them based on borrowing against their property value/equity.
This may be paid as:
- A lump sum.
- A series of fixed monthly payments (either for a set period of time or for as long as the homeowner lives in their property).
- A line of credit.
- A combination of any of the above.
In most cases the reverse mortgage will not require the homeowner to make any repayments on the money that they borrow until they move out of their home, sell the property or die.
Reverse mortgages are commonly taken out from as HECMs (Home Equity Conversion Mortgages) which are federally backed by the U.S Department of Housing and Urban Development. They can also be found in some states as single purpose products and as private loans from commercial companies.
What are the Advantages and Disadvantages of a Reverse Mortgage?
For many, this is a relatively easy way of releasing equity from their home without having to make significant lifestyle changes. Some of the advantages of doing this include:
- The homeowner may be able to access money to help them with everyday living costs, repay other debts, pay for healthcare costs or make home renovations.
- They will not have to sell their home to raise the money they need.
- They will not have to generally repay what they release until they sell up, move on or die.
- Proceeds from this kind of deal are usually tax free and won't affect benefits such as Social Security or Medicare (although other benefits may be affected).
There are some downsides that should also be considered before looking at a reverse mortgage. These include:
- The sum borrowed will increase over time as interest is added to it which could eat into any assets that the homeowner will have to leave to his/her relatives.
- There are fees and charges involved in setting up and managing this kind of product.
- Many reverse mortgages will only offer variable rates of interest which could see total borrowing costs fluctuate over time.
Consumers looking into reverse mortgages as a way to free up some cash may be offered or expected to take financial counseling before they sign up to an agreement. This may an important thing to do as it will help explain other options that may be available to them and will help make sure that they fully understand how these kinds of loans work before making a commitment.
A reverse mortgage calculator may also be useful during the process for those looking for an estimate of how much they might be able to borrow.
Sources: www.reversemortgage.org, www.ftc.gov
Carol Finch - Carol Finch is the Topic Editor for Retirement Planning, Budgeting, E-Commerce & Technical/Business Writing on Suite101.
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