What You Give, What You Get
For people over 62 with significant home equity, reverse mortgages can offer additional cash flow, an avenue for staying in the home they love as they age, and even an opportunity to continue investing after leaving the workforce. But, reverse mortgages are loans, and like any loan, in exchange for access to loan proceeds, the borrower pays upfront fees and interest and must adhere to specific terms and conditions to remain in good standing with the loan provider.
Anyone who takes out a reverse mortgage must undergo counseling to help ensure they understand and can meet the terms of the loan. Understanding the tradeoffs made with a reverse mortgage can also help borrowers and their children feel confident they are making the right decision.
The following are some facts about the value exchange that occurs with a reverse mortgage.
Exchange #1: Higher Fees and Interest for Increased Cash Flow
Due to federal protections and how the loans are structured, reverse mortgages can cost borrowers more than a traditional mortgages.
While most closing costs are similar to those with a traditional mortgage, the U.S. Department of Housing and Urban Development (HUD) requires all HECM borrowers to pay an upfront Mortgage Insurance Premium (MIP). The MIP allows the Federal Housing Authority (FHA) to insure the loan but does add an extra cost to closing (borrowers must also pay annual FHA MIP as well).
Reverse mortgages also tend to have higher interest rates. However, reverse mortgage borrowers do not see the impact of interest the same way traditional mortgage borrowers do. Instead of the borrower paying off interest as part of their monthly payments, it is added to the loan balance every month and will be due at the end of the loan.
In exchange, reverse mortgage borrowers forgo mandatory monthly mortgage payments. While they are still responsible for homeowners insurance premiums, property taxes, and other housing-related expenses, monthly principal and interest payments are not required. This means that cash the borrower previously had to reserve for monthly mortgage payments is free to use for other purposes.
Exchange #2: Home Inheritance Later for Financial Stability Now
A reverse mortgage allows borrowers to leverage home equity to access immediate cash proceeds. In many cases, with the supplemental income the reverse mortgage provides, borrowers who would otherwise have relied on their adult children for financial support can relieve their children of that burden. While not ultimately getting the house may be disappointing, taking away the financial onus of supporting parents allows adult children to focus on saving for their own retirements. Accessing funds from a reverse mortgage can often provide choices for the borrower and their heirs with more financial options than they would have had otherwise.
A reverse mortgage is a private transaction, and you are not required to discuss it with anyone. However, discussing it with your children and other trusted advisors can be part of good planning. Specifically, discussing the loan with your children, so they are fully aware of the terms and the reasons for your decision can help prevent misunderstandings and disappointment down the road.
Exchange 3: Home Equity for Flexibility
Rather than having the bulk of their net worth tied up in their home, reverse mortgage borrowers have the flexibility of tapping their built-up equity to use for anything they want or need. Whether that means paying down crippling medical bills, making investments to help secure a more profitable retirement, upgrading the home, or taking a dream vacation, using the loan proceeds is at the borrower’s discretion.
In exchange for this financial flexibility, the borrower will have less equity in the home. However, as long as the loan terms are met, they can continue to own and live in the home.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.
By Rudri Bhatt Patel