Reverse Mortgages: An Overview
Boomers ready to retire may find themselves house rich and cash poor. Rapid appreciation of personal real estate coupled with five years of a sideways stock market presents a liquidity problem for retirement planning.
The solution for some may lie in a reverse mortgage. In simple terms a reverse mortgage offers the opportunity for a property owner to tap the equity in their home without having to pay back the loan during their life or while they live in the home.
This is accomplished by entering into an agreement with a lender who is willing to advance a sum of money against the equity in the home, either in the form of a lifetime annuity, a lump sum or a line of credit with the understanding that the lender will recover the loan plus interest when the home is sold or the owner passes on.
The amount that can be advanced is a function of three factors. First, the owner(s) must be age 62 or older. Second, the amount advanced will depend upon the value of the home. Finally, interest rates in effect at the time of the loan figure into the equation. For example, an older borrower with a more valuable home during a low interest rate environment will have access to more cash than one faced with the reverse.
A reverse mortgage differs from a home equity line or conventional mortgage in several significant respects. First, the borrower does not have to meet borrowing qualification standards for credit, income, assets and ability to repay the loan. The borrower does not have to make periodic payments. And, the borrower cannot lose the home for non-payment.
For a home to qualify it must be the principal residence, either a single family residence, a 2-4 unit building, or a federally-approved condominium or planned unit development. The home cannot be a mobile home, but some programs offer loans on “manufactured” homes, providing they are on a permanent foundation and taxed as real estate.
Homes must be free of debt. Owners with an existing mortgage can utilize the opportunity to withdraw a lump sum to pay off the mortgage although that will reduce the amount of income available.
Payments can be structured and/or combined into a number of formats. Lump sums, lines of credit, monthly payments and lifetime annuities are the most popular. Some line of credit programs provide for the credit line to increase each year, recognizing the increasing property value. Loans that offer lifetime payments obligate the lender to keep paying even if the value of the home is exceeded. The lender must accept the value of the home for their only source of repayment.
Payback of the loan is due when the principal owner fails to occupy the house for 12 consecutive months or more, sells the home, or dies and leaves the home to heirs.
Reverse mortgages work well for older owners who are reasonably sure they intend to live out their lives in their homes. Before considering a reverse mortgage in such circumstances the owner should give careful considerations to their home’s “senior friendliness.” A “senior friendly” home ideally is all one level, with wide passageways for walkers and wheel chairs, and accommodative bath facilities. It should be located in a neighborhood accessible to public transportation and shopping for basic necessities, or the owner should have a plan to handle those situations when driving is no longer possible.
Finally, those considering a reverse mortgage should bear in mind that they are spending their children’s inheritance. If leaving the home as a legacy is important, a reverse mortgage, with its high fees and compounding interest, will take a large chunk from this legacy.
Reprinted with permission. The opinions expressed are those of Wendell Cayton, a Registered Investment Advisor in the states of California and Washington, and not those of any company with whom he is associated. He may be contacted at Cayton@ix.netcom.com.