Is a Reverse Mortgage Right for You?
by FirstWave Financial
Reverse mortgages have gained a degree of credibility in recent years as part of an overall lifetime spending strategy for retirees. After all, people are living longer and need additional tools for meeting the challenge of making their savings last. As Wade Pfau, professor of retirement income in the Financial and Retirement Planning Ph.D. program at the American College, states, “A reverse mortgage can increase a retiree’s flexibility to meet spending objectives by integrating an otherwise illiquid asset into an overall framework for how best to spend down assets in retirement.” Despite the additional flexibility a reverse mortgage can offer, high costs remain a significant barrier to widespread adoption among retirees. Reverse mortgages, therefore, are probably best viewed as a tool to use or not use depending on an individual’s unique circumstances and available alternatives.
A reverse mortgage is a loan secured by a mortgage. The difference compared to a regular (forward) mortgage is that reverse mortgage borrowers aren’t obligated to repay the loan until they die or sell the home. To qualify for a reverse mortgage, a borrower must be at least 62 years old and own the home outright (or very close to it). Additionally, the borrower must have the wherewithal to continue to pay for insurance and taxes on the home. Proceeds can be received either as a lump-sum, a series of payments, or the loan can be structured as a line of credit to be tapped into on an as-needed basis. It is worth noting that because of problems with defaults in the past, those who receive lump sums will be able to borrow less.
Interest rates on reverse mortgages are typically variable. Only with lump sum reverse mortgages are fixed rates available.
The amount one may borrow depends on the borrower’s age, the value of the home and prevailing interest rates. The loan amounts depending on the home’s value is obvious because the more a home is worth, the more equity the borrower has available. The older the borrower is, however, the more he can borrow because there is a shorter time for interest to accrue on the loan. Similarly, the lower interest rates are, the more one can borrow because interest compounds less quickly.
When a reverse mortgage borrower dies or sells his home, he settles up with the lender. The borrower’s heirs will have to pay off the debt in order to keep the home if that is their goal. Sometimes the debt is greater than the home’s value. One of the benefits of a reverse mortgage is that the borrower (or his heirs) is off the hook for the difference between the debt and the sale proceeds because the shortage is covered by the mortgage insurance that the borrower paid for.
As mentioned, reverse mortgage costs represent a high hurdle to overcome. Upfront costs include mortgage insurance (.5% of the home’s value), closing costs (which in Florida includes steep mortgage taxes) and loan origination fees (between $2,500 and $6,000, depending on the value of the home). In addition to the upfront costs, borrowers are obligated to pay ongoing mortgage insurance amounting to 1.25% of the outstanding debt. In other words, someone with a $250,000 home can expect to pay at least $9,000 in closing costs.
So is a reverse mortgage something you should consider? While there is research to suggest that a reverse mortgage line of credit can enhance retirees’ prospects for never spending down their assets in retirement, very close consideration should be given to the high costs associated with reverse mortgages relative to other alternatives, such as home equity lines of credit, downsizing, etc. before proceeding. The WealthCoaches™ at our wealth services firm in Satellite Beach, FL – Melbourne/Brevard can help you craft a WealthPlan™ based on your individual situation and goals.