Older homeowners may find that they want or need to raise extra cash during retirement years. Reverse mortgages offer seniors the chance to use their home equity to finance lump sums, regular monthly payments or lines of credit. What is a reverse mortgage and how does it work?
What are Reverse Mortgages?
Although these products are known as mortgages, they work differently to regular home purchase loans. Here, the lender pays the homeowner for some of their equity stake in a property. This reverses the traditional mortgage lifecycle where you pay down a loan incrementally and see equity ownership increase.
Using this method to raise cash for retirement years will see your loan grow over time and your equity decrease as repayment is deferred. Basically, you are able to tap into the value of your home without having to make immediate loan repayments or to sell up and move.
How do Reverse Mortgages Work?
Any cash you are given from a reverse mortgage is essentially a loan made against a property with a future repayment based on residency criteria. Depending on preference, and the product you choose, this may be given as:
- A lump sum.
- Monthly payments (for a set term or for the time that you live in the property).
- A line of credit.
In some cases, you may also be able to combine payment types.
This cash and the interest charged does not need to be repaid immediately but falls due when you no longer use your home as a principal residence (i.e. when you or the last surviving borrower dies, sells the property or moves out permanently).
HECM and Proprietary Mortgages
The most commonly used reverse mortgage is the HECM (Home Equity Conversion Mortgage) which is insured by the FHA (Federal Housing Administration). It is also possible to use privately-backed proprietary products as an alternative. Each option comes with its own eligibility criteria and pros and cons.
A HECM, for example, may have higher charges but lower interest rates and a proprietary lender may charge less up-front but more in interest. Although most homeowners with equity to use as collateral can raise cash this way, the funds released may vary depending on lender limits, age, property type and the value of the home. Calculators, such as the AARP reverse mortgage tool, can give useful estimates on possible cash payments.
What are the Pros and Cons of a Reverse Mortgage?
For some seniors, reverse mortgages can be a simple way to access home equity without having to sell up or use a regular income-based loan. They can use the cash as they like and do not have to worry about repayment (provided lender conditions are met) until they move out of the property. At that point, a lender cannot charge more than the value of the home and any money left over will belong to the homeowner/ estate.
Home equity is, however, often the last financing resort for many seniors and you should be careful to think about your future needs once this cash has been spent. A reverse mortgage will also eat into the funds that you could leave as part of your estate and your heirs may have to sell up to make the repayment. This may also not be the best short-term solution as up-front costs can be high, and it may better suit those with increased financial needs that cannot be met in other ways.
Consumer protection measures, such as independent counseling, have been set in place to help seniors make an informed decision before opting for reverse mortgages. The National Council on Aging runs a HUD-approved service which may be useful. This is free to use unless you choose to proceed with an application.
Sources: AARP (Reverse Mortgage Loans); ReverseMortgage.org. Accessed online 17th January, 2011.
Carol Finch - Carol Finch is the Topic Editor for Retirement Planning, Budgeting, E-Commerce & Technical/Business Writing on Suite101.
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