Tuesday, August 17, 2010

Reverse Mortgage: Is it Right for You?

Overview

A Reverse Mortgage or Reverse Home Mortgage is a one of the popular among seniors’ financial products to use in their retirement plan.

When looking for ways to get cash from their home, most people consider selling their house or borrowing against their home equity and making monthly loan repayments on a home equity loan. With a Reverse Home Mortgage, you get all the benefits of selling your house and all the benefits of getting a home equity loan - but you can still live in and retain ownership of your home and you don’t have to make any payments against the loan over time. No matter how you structure a Reverse Mortgage, you typically don't pay anything back until you die, sell your home, or permanently move out. On top of that, your ability to secure a Reverse Mortgage is not dependent on your credit history, income level, health or any other factors that might make a home equity loan expensive or problematic.

By converting your home equity into income, a Reverse Mortgage can be a way to stay in your home and get cash to use for any purpose. There are no restrictions on how you can use the money from a Reverse Mortgage.

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To be eligible for most Reverse Mortgages, you must own and reside in your home and be a senior 62 years of age or older. (In most cases second homes, apartment buildings and homes less than a year old are not eligible for a reverse mortgage.)

How Reverse Mortgage Works?

With a reverse mortgage, a lender makes payments to you based on a percentage of the value in your home. When you no longer occupy the property, the lender sells it in order to recover the money that was paid out to you.

While there are several types of reverse mortgages, including those offered by private lenders, they generally share the following features:

  • Older homeowners are offered larger loan amounts than younger homeowners. More expensive homes qualify for larger loans.
  • A reverse mortgage must be the primary debt against the house. Other lenders must be repaid or agree to subordinate their loans to the primary mortgage holder.
  • Financing fees can be included in the cost of the loan.
  • The lender can request repayment in the event you fail to maintain the property, fail to keep the property insured, fail to pay your property taxes, declare bankruptcy, abandon the property, or commit fraud. The lender may also request repayment if the home is condemned or if you add a new owner to the property's title, sublet all or part of the property, change the property's zoning classification, or take out additional loans against the property.
The amount that can be borrowed is based on several other factors:
  • The age of the youngest homeowner -- all titled owners have to be at least 62, and the older the owners, the more they can borrow.
  • The appraised value of the home.
  • The county in which the property is located.
  • The interest rate at closing.
When Is a Reverse Mortgage Appropriate?

Reverse mortgages offer the following advantages for those who qualify.
  • Tax-free funds with no restrictions
  • Flexible repayment alternatives
  • No income qualifications
  • No downside risk for the homeowner
Generally, homeowners who can afford to reduce the proceeds from the sale of their homes by the amount of the mortgage are potential candidates, which in many cases will be clients who intend to live in their homes until they die. Clients seeking to reduce their taxable estates may also be interested in this type of loan.

Reverse mortgages may have certain requirements. For example, most reverse mortgages mandate that homeowners must keep their homes in relatively good condition for the duration of their tenure. This may be impossible for those with health or other physical problems, and those who cannot meet this condition will most likely face foreclosure. Paying for upkeep may also be unaffordable for many homeowners, particularly retirees living on fixed incomes. Reverse mortgagees must therefore consider this implication carefully and find out exactly what the lender will require of them in the way of maintenance and upkeep.

Homeowners who intend to pass their homes on to their heirs also need to carefully consider the fine print found in many reverse mortgages. Although homeowners themselves cannot owe more than the value of the home, most reverse loan documents stipulate that upon the homeowner's death or cessation of the homeowner's residence in the house, homes with mortgage balances greater than the home's value will be repossessed. The only alternative is for the heirs to produce the balance in cash.

Using the proceeds from a reverse mortgage as a funding source for investments, especially investments that are not guaranteed, is not a very good idea. Even investments that pan out must do extremely well over time before they will beat the high fees and adjustable interest rates charged by most reverse mortgages. Finally, low-income borrowers must be aware of the impact that the proceeds of a reverse mortgage may have on their eligibility for public assistance, such as Medicaid. This cannot affect Social Security and Medicare assistance however.

Using Reverse Mortgages to Pay for Insurance Coverage

Using the funds from a reverse mortgage to pay for long-term care (LTC) or life insurance can be a much more sensible alternative for borrowers seeking to reduce their liabilities. Granted, this course of action can require careful analysis and forethought, but there are times when a person is relatively certain that they will need LTC and can use a reverse mortgage to pay the cost of premiums that would most likely be unaffordable otherwise. Admittedly, this type of tradeoff can result in the repossession of the home if the homeowner does eventually require care, but this may still be a preferable alternative to forced liquidation of all of the insured's assets (including the home) if a level of care is needed for which there is no coverage.

Homeowners may fund a life policy, even if the mortgage balance exceeds the value of the home at death. A homeowner who purchases a high enough cash value policy with reverse mortgage proceeds that exceed the home's value will still leave his or her heirs in a better position after they have paid the difference than before.

Types of the Loans

HECM Loans 

Reverse mortgages have been around since the 1960s, but the most common reverse mortgage is a federally-insured home equity conversion mortgage (HECM). These mortgages were first offered in 1989 and are provided by the U.S. Department of Housing and Urban Development (HUD). HECMs are the only reverse mortgages issued by the federal government, which limits the costs to borrowers and guarantees that lenders will meet the obligations. The primary drawback to HECMs is that the maximum loan amount is limited.

Non-HECM

Non-HECM reverse mortgages are available from a variety of lending institutions. The primary advantage of these reverse mortgages is that they offer loans in amounts that are higher than the HEMC limit. One of the drawbacks of non-HECM loans is that they are not federally insured and can be significantly more expensive than HECM loans.

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Reverse Mortgage – a Risky Product

In many circumstances, however, a reverse mortgage can be a risk to your financial security. Here are six dangers you should consider before signing on the bottom line:

1. Complexity. Each lender offers slightly different products under the reverse mortgage banner. The rules are often complex and the contract you sign can be full of hidden landmines. The program will outline fees and interest, along with rules for repayment or default. Regardless of what the salesperson says to you verbally, have a lawyer review the contract and explain it to you in plain English before signing.

2. Pressure. Like the sale of any product where the salesperson is being paid a commission, reverse mortgage pitches can be forceful and intense. Some financial planners tout reverse mortgages as a way to fund investments, such as annuities. The costs of the reverse mortgage, however, may completely erase any benefit of investing in other products, leading borrowers to risk losing their homes. Lenders cannot force you to use your reverse mortgage proceeds for any particular purpose. It pays to have some time to consider the product and the pros and cons of using it as a source of funding. Never sign a reverse mortgage contract on the spot.

3. Future Health. This is perhaps the largest risk of a reverse mortgage. You can't predict the future. Reverse mortgages come with stipulations about which circumstances require immediate repayment or foreclosure on the home. Some outline how many days or months the property can sit vacant before the lender can call the loan. For example, if you have a heart attack and spend three months in hospital and residential rehabilitation, the lender may be able to call the loan and foreclose on the house because it is unoccupied. The same is true if you have to go into an assisted living facility. The reverse mortgage must be repaid or the house must be sold.

4. Eligibility for Government Programs. Certain government programs, such as Medicaid, are calculated with reference to your total liquid asset base. If you have reverse mortgage proceeds that you haven't yet spent, they may affect your eligibility for some of these plans. Before signing a contract, check with an independent financial professional to ensure that the cash flows from a reverse mortgage won't impact other funds you receive.

5. High Fees. When considering taking equity out of your home in the form of a reverse mortgage, all of the loan origination and servicing fees must be taken into account. Many of these fees can be buried in the expansive loan documents and should be thoroughly reviewed before signing the contract. Reverse mortgages can be a very expensive way to tap into the equity in your home, so be sure to look at other alternatives, such as home equity loans, if you qualify.

6. Spousal Eviction. In cases where only one spouse's name is on the reverse mortgage contract, the house can be sold out from under the other spouse if the borrower dies. All reverse mortgage contracts require immediate repayment on the death of the borrower. Federal law limits the amount due to the lesser of the total loan balance or 95% of the home's market value. If repayment cannot be made from other estate assets or other assets of the spouse, the house must be sold to repay the loan, leaving the spouse homeless. 


Conclusion

No matter how attractive the reverse mortgage offer may sound, you need to understand that it is a very specific financial product, which does not fit to everybody’s needs. Don’t leave your family out of the process of getting a reverse mortgage, especially grown children. Try to get a consensus among your heirs prior to proceeding with the Reverse Mortgage, or at least include them during the education process. A reputable lender will welcome speaking with any of your family. Be aware that the loan and the process is confidential and that the lender can only speak with family members if you give permission.

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Consider discussing the benefits and disadvantages of reverse mortgages with your financial planner or real estate attorney. You can avoid reverse mortgage pitfalls if you have an impartial party clearly explain the ramifications.

Some Words of Advice:

  • Obtain independent legal and other financial advice prior to signing loan documents. Discuss the loan with trusted family members;
  • Know that reverse mortgage loans cannot have prepayment penalties or restrictions. Loans must be able to be prepaid in full or in part at any time without penalty;
  • Understand your obligations under the loan, i.e., to pay taxes, insurance, and maintain the property in a satisfactory condition. Failure to fulfill these obligations may constitute a default and possibly lead to foreclosure action;
  • Understand that over time the loan balance may increase and impact the accumulated equity in your property, leaving little or no reserve for potential unexpected expense such as health care and home repair.

Sources and Additional Information:


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