By Montoya M. Ho-Sang
A reverse mortgage is a unique type of loan for homeowners age 62 and older. This special type of loan is insured by the Federal Housing Administration (“FHA”) and allows homeowners to access the equity in their homes, without making monthly mortgage payments. Borrowers are not required to repay the reverse mortgage loan as long as they live in the home. However, the loan must be repaid when the last surviving borrower dies, moves out, or sells the home. Research shows that borrowers typically use the money to pay for home renovations, medical, and daily living expenses. Additionally, some borrowers actually take out a reverse mortgage to pay off an existing mortgage, to eliminate the burden of monthly mortgage payments. The amount homeowners can borrow varies by lender but generally is based on age, home value, and the interest rate at the time of closing.
There are certainly pros and cons to a reverse mortgage. Reverse mortgage are helpful because they include flexible disbursement options, no monthly mortgage payments, the possibility to eliminate existing mortgages, and the proceeds are generally tax free. Potential downsides of reverse mortgages include: fees are typically higher than traditional mortgages, certain needs-based government programs may be affected by taking out a reverse mortgage, and the inability to add new borrowers to a reverse mortgage loan.
There are also questions surrounding the marketing of reverse mortgage products. A recent study by the Consumer Financial Protection Bureau (CFPB) found that reverse mortgage advertisements were confusing and gave the false impression that the loans were a type of a government benefit or guaranteed that the borrower could remain in the home for the rest of their lives. Moreover, the CFPB has compiled approximately 1,200 reverse mortgage complaints received from December 1, 2011 through December 31, 2014. Thus, it is clear that with an increasing number of Baby Boomers taking out reverse mortgages, there is a need for additional clarification on the topic.
Here are a few things to think about if you are considering taking out a reverse mortgage:
- Borrowers must remain current on their property taxes, homeowner’s insurance, and any homeowner association fees. Additionally, the borrower must maintain the home according to FHA guidelines.
- A recent CFPB report found that nearly 10 percent of reverse mortgage borrowers are at risk of foreclosure because they failed to pay these expenses. Therefore, it is important to have other retirement resources to alleviate the burden of paying property taxes, insurance, and any homeowners’ association fees.
- There are limits to the amount of money you can draw from your loan in the first year.
- Generally, borrowers are capped at taking out 60% of their initial principal limit during the first year. Borrowers, typically, encounter issues when they take out a large lump sum payment. This can become a huge issue for borrowers who essentially outlive their reverse mortgages. Borrowers should consider taking out monthly payments or a line of credit to avoid some the lump sum pit falls.
Plans for staying in the home or leaving it to family members
- A reverse mortgage makes more sense the longer you live in your home, in order to increase your accessible equity. If heath issues or other issues may cause you to move out of your house too soon, a reverse mortgage may prove to be an expensive way to cover short term cash needs. Reverse mortgages are best suited for homeowners who are healthy, intend to stay in their home for a long period of time, and are financially stable, but may need the extra income to supplement Social Security or to pay living expenses or medical bills.
- When the reverse mortgage loan becomes due, the borrower’s heirs can choose to repay the loan and keep the home or sell the home to pay back the loan. If the home sells for more than the remaining balance on the loan, the excess funds go to the heirs. Fortunately, if the home sells for less than the balance owed, the estate is not required to pay more than the value of the home at the time the loan is repaid.
Access your current financial status
- The CFPB advises that homeowners with minimal retirement incomes first determine whether they qualify for state and local programs, including subsidized housing and utility discount programs, before taking out a reverse mortgage. Moving to a more affordable home may be best option to reduce overall living expenses.
Protections for surviving family members
- In the past, couples who took out reverse mortgages in the name of only one spouse encountered issues when the borrowing spouse died. Historically, when a borrower died, the surviving spouse had to pay back the loan in full or move out of the residence. There have been recent changes which allow surviving spouses to continue living in the home under certain conditions. However, the surviving spouse will stop receiving payments from the reverse mortgage after the borrowing spouse’s death. In order to avoid these issues, couples should borrow jointly, if possible so the surviving spouse can continue to receive monthly payments and continue to live in the home.
In order to combat some of the difficulties certain borrowers experience with reverse mortgages, homeowners interested in obtaining a reverse mortgage must to receive free mandatory counseling by an independent third party, typically an agency approved by the Department of Housing and Urban Development or a national counseling agency such as AARP. These organizations help homeowners review alternative options. Available resources should be utilized by homeowners thinking about a reverse mortgage, as it could end up being a very costly mistake if a reverse mortgage does not fit current needs. Homeowners and relatives of older homeowners considering a reverse mortgage should absolutely seek the counsel of a financial advisor or attorney to evaluate their specific needs and determine if a reverse mortgage is right for them.
Montoya M. Ho-Sang is a litigation attorney in Baker Donelson’s Atlanta office.
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