Latest posts by Elena Tahora (see all)
- Why Reverse Mortgages Might Not Work for Retirement Income - March 9, 2017
With a reverse mortgage, older homeowners have the opportunity to borrow money against the equity in their home if they have a small existing mortgage or own their home outright. This type of mortgage is now a popular way for baby boomers who are finding ways to fund their retirement. A reverse mortgage, referred to as a Home Equity Conversion Mortgage (HECM), is a unique kind of loan for all homeowners aged 62 (and older) through which they can liquidate a part of their equity in their home.
This is different from a second mortgage or conventional home equity loan as no repayment is required until and unless they are unable to meet their mortgage obligations. This sounds like an ideal deal for retirees. However, a reverse mortgage has several drawbacks and should only be considered by a small group of people who have strong reasons to go for it.
Image byAmerican Advisors Group/ Flickr
Unlike a typical home loan, instead of you paying the bank, the bank pays you, and the loan has to be repaid when you move out, sell the house or die. Homeowners can receive this money as a lump sum, a line of credit or a monthly payment and the amount that can be borrowed depends on your age (62 years to qualify), your total equity and current interest rates with the length of the loan term.
Why Is It Not A Good Retirement Strategy?
The fee expenses attached to a reverse mortgage can be high. All expenses pertaining to origination fees, service, a mortgage insurance premium and closing costs may be too much to bear. In case an individual dies, the home has to be sold to repay the mortgage. Therefore, it is likely that the home does not pass to a homeowner’s heirs unless they have repaid the balance. Moreover, the loan has to be repaid if the homeowner moves out of the house or does not live in the house for more than a year. This also includes entering into a long-term care facility.
As a homeowner still owns the home even after he signs up for a reverse mortgage, he will be responsible for paying all property taxes, maintenance, insurance as well as other expenses. In case the homeowner fails to manage regular expenses, he may end up forfeiting his home. Along with higher fees on the front end, interest rates for reverse mortgages are higher as compared to a conventional mortgage. They are also usually higher than a HELOC (home equity line of credit)
Reverse mortgages may offer a few benefits but borrowing money as a lump sum or via monthly payments is not the ultimate option for people looking for easy ways to pay off a mortgage. It is mostly ideal for individuals who have no heirs or almost negligible retirement funds. Reverse mortgages can be used as part of an overall retirement plan but should not be considered if you are facing a financial crisis. If you find yourself struggling on a limited income, there are several other public and private benefits other than a reverse mortgage that can support your finances without a higher interest rate.
What You Should Do
If you are facing financial issues and are under stress, seek advice from a financial advisor who may be able to suggest you a way other than a reverse mortgage for managing your expenses. Saving a little extra money each month goes a long way. Plan and map out your finances and do not consider a reverse mortgage as a financial crisis management tool for funding your retirement.