That particular retirement scenario is why reverse mortgages were invented by the U.S. Department of Housing and Urban Development in 1988. The most common reverse mortgage is a Federal Housing Authority-insured Home Equity Conversion Mortgage. It is unique in that the homeowner receives the cash up front, but does not repay the loan and interest until the end of the borrowing term. The cash can be taken in a lump sum, monthly payments or a line of credit. The loan is available to homeowners 62 and older who own their home and use it as their primary residence. The home can be paid off or have a mortgage.
The amount a homeowner is able to borrow depends on his age, the current interest rate and the value of the home. The loan is not due as long as the home remains the principal residence of the borrowers. The homeowner must pay the property taxes, homeowners insurance and maintain the property. The HECM comes due when the last surviving borrower permanently leaves the home. Generally, the property is sold with the proceeds used to repay the HECM. If the borrower owes more than the house is worth, the homeowner’s estate is not responsible for the difference. If the proceeds from the home’s sale are greater than the loan, the remaining funds go to the homeowner’s estate.
Sounds too good to be true? Possibly, as reverse mortgages have their drawbacks. The amount the borrower can receive is based on the age of the youngest borrower, appraised value of the home and the current interest rate. Additionally, loan origination fees, application fees, insurance and closing costs all reduce how much is available to borrow. These fees can be considerably higher than the fees on a conventional mortgage, primarily because of the FHA required mortgage insurance. Once you have a reverse mortgage, you cannot get a second mortgage or home equity loan. If all the loan funds are used before the last surviving borrower leaves the home, the borrower may not have any collateral for another loan.
Because of these and other reasons, applicants must first meet with HUD counselors to determine if a reverse mortgage is an appropriate solution. Reverse mortgages are not a solution for all seniors. Those considering one should also talk with a financial adviser to see how this financial move may affect Supplemental Security Income or Medicaid.
William G. Lako Jr., CFP, is an executive in residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial. Lako is a certified financial planner.The MDJ will periodically publish columns from KSU business faculty.