June 10, 2010
With the worst recession in recent memory, many senior citizens are looking for ways to increase income. A reverse mortgage may, or may not be the answer, according to financial advisors at the Federal Deposit Insurance Corporation (FDIC).
A reverse mortgage is essentially a loan against your home that you do not have to pay back for as long as you live there. It allows homeowners age 62 or older to borrow cash from the equity in their homes without having to make monthly payments.
You've probably seen ads for reverse mortgages, portraying them as a great source of easy money for older homeowners to supplement their income, pay healthcare expenses or use the money as they please. While there are potential benefits to a reverse mortgage, it may not be the best option for everyone.
With the number of potential borrowers growing with the aging population, it's important that homeowners fully understand the risks involved. Remember -- a reverse mortgage is a loan that must be repaid.
"Not all advertisements clearly indicate that a reverse mortgage is a loan," said Mira Marshall, an FDIC Section Chief specializing in consumer issues. "In fact, a reverse mortgage is a very complicated loan that uses home equity as collateral, just like the mortgage you probably used to purchase your home."
Reverse mortgages allow homeowners to receive cash in a lump sum, through monthly payments, as a line of credit whenever they need money, or any combination of these options. Unlike traditional mortgage products, homeowners do not make any monthly payments to the lender.
Loan amount grows over time
However, they eventually do have to repay the principal and interest when they move, sell the house or die. And, because no monthly payments are being made, the amount owed will grow over time as interest costs build up and, in some cases, as additional funds are advanced.
The borrower also remains responsible for paying the property taxes and insurance and maintaining the house. Failure to do so can cause the reverse mortgage to become immediately due and payable in full.
The rules to determine how much you can borrow through a reverse mortgage are complex. For example, the total amount of cash available is a percentage of the home's value that will vary by the age of the borrower and the location of the property. And if there's a co-borrower, the value is determined by the age of the youngest borrower.
Let's say your house has a market value of $250,000, you owe nothing on a mortgage and the youngest co-owner is 70 years old. Even though your home equity is about $250,000, with a reverse mortgage and depending on the location of the property, you can borrow only up to approximately $130,000. In contrast, with a traditional home equity loan, it may be possible to borrow up to 100 percent of the value of the home.
Interest can eat up all equity
Borrowers also should keep in mind that the more cash they take out and the longer they go without making loan payments, the interest charges and other costs can use up much or all of the equity, leaving fewer and fewer assets for the borrower or heirs. And if you or your heirs want to keep the house instead of selling it, the full loan amount would be due and payable from your own funds, even if its more than the value of the property.
"Because the costs and fees can be extremely high," said Mike Evans, an FDIC Fair Lending Specialist, "most experts generally advise homeowners not to take out a reverse mortgage if they plan to stay in their home less than five years or if they simply need extra money for small expenses."
Do your homework
FDIC recommends that you do your research and shop around before committing to a reverse mortgage. To understand the potential pros and cons of a reverse mortgage, talk to financial advisors and qualified housing counselors. Depending on your circumstances, there may be other, less expensive options available to you.
Explore different kinds of loans and programs from local government agencies or nonprofit organizations. In some cases, it may even make financial sense to sell your home and downsize to a less expensive home or even a rental.
If you decide that borrowing money is the way to go, contact several lenders and compare the costs and benefits of the options they offer.
"Most financial experts also agree that it is never a good idea to use the funds from a reverse mortgage to purchase other financial products or services," said David Lafleur, an FDIC Senior Examination Specialist. "Not only will you immediately incur expensive interest charges and other fees in connection with the reverse mortgage, but having large deposits or annuities may make it tougher for you to qualify for certain entitlement programs that take assets into consideration, such as Medicaid. Also, if you tie up money in CDs or annuities, you will be giving up easy access to funds you may need to meet your expenses."
