For most retired homeowners, the largest asset they possess is their home’s equity. After decades of making mortgage payments, most retirees have the biggest proportion of their wealth tied to their home. If a homeowner is unable to cover their living expenses after retirement, they can supplement their income by taking out a reverse mortgage.
What is a reverse mortgage?
A reverse mortgage is a financial product that allows a homeowner that meets certain age requirements and has sufficient home equity to borrow against the value of their home. As opposed to a forward mortgage, a reverse mortgage pays funds to the homeowner through a lump sum, fixed monthly payments, or line of credit–while also eliminating required mortgage payments.
When the borrowing homeowner dies, relocates permanently, or decides to sell their home, the entire loan balance becomes due.
What are the benefits of a reverse mortgage?
Taking out a reverse mortgage is one of the best ways for homeowners to supplement their income and handle unexpected expenses. Other potential benefits of a reverse mortgage include:
- Flexible monthly payments. Housing costs comprise a large proportion of an average homeowner’s income. By taking out a reverse mortgage, you will no longer be required to make mortgage payments every month, thus freeing up a considerable portion of your income. Any payments that are made reduce your outstanding loan balance, freeing up equity that can be borrowed back later or passed to your heirs.
- Qualification requirements are less strict. The requirements for taking out a reverse mortgage are far less strict than applying for a forward mortgage. Because you don’t have to make monthly payments, your credit score and current income are less significant when applying for a reverse mortgage.
- Income and savings boost. Retiring can cause a considerable decrease in your monthly income, which can require significant lifestyle changes and may lead to financial instability. A reverse mortgage can give you the funds you need to supplement your income, pay for sudden expenses, or increase your cash reserves.
- Non-taxable proceeds. The Internal Revenue Service (IRS) does not classify reverse mortgage proceeds as income, which means they are not subject to income tax. As a result, all proceeds from this program are tax-free.
- No liability for your estate. When you die, the loan becomes due and payable. If you have surviving heirs, they can either pay the loan balance and keep the house or allow the lender to sell it. Even if the proceeds of the sale are less than the loan balance, your heirs will have no liability beyond the value of your home.
What are the possible disadvantages of a reverse mortgage?
Taking out a reverse mortgage can help improve your financial situation, but just like any financial product, there are certain things that you should be aware of:
- Fees and interest. When you take out a reverse mortgage, a portion of your home equity will be used for associated loan fees and interest.
- Possible early repayment. Unless you choose to set aside funds during the application process, you are required to continue to make your property tax and homeowners insurance payments. Failure to make these payments or properly maintain your home could result in the loan becoming due and payable.
- Maximum loan limit. As of January 1, 2021, the maximum you can borrow with a Home Equity Conversion Mortgage (HECM) is $822,375, even if your home is appraised for higher than that amount. Proprietary reverse mortgage products allow you to tap into additional equity, but are not backed by the Federal Housing Administration (FHA).
- Surviving spouse loan payouts. If you die or live in a healthcare facility for more than 12 months, your spouse may not be able to receive reverse mortgage payouts unless they are a co-borrower on the loan.
Who should apply for a reverse mortgage?
Deciding whether a reverse mortgage is a smart option for you depends on your lifestyle, your future goals, and other major factors.
Taking out a reverse mortgage makes sense if:
- You have sufficient equity in your home
- You need to supplement your retirement income, bolster your savings, or pay for emergency expenses
- You no longer plan to move for the rest of your life
- You can afford ongoing costs such as property taxes, homeowner’s insurance, and property maintenance
Economic Instability Among Retirees
If you’re like many other retirees, your income has likely declined significantly since you left the workforce. If you are still paying your forward mortgage loan, budgeting your pension and other sources of retirement income can be very difficult. Healthcare costs also tend to increase as you age, emphasizing the importance of a safety net for sudden expenses.
According to the National Council on Aging (NCOA), over 15 million Americans aged 65 and older suffer from economic insecurity, with incomes falling 200% below the Federal Poverty Level. 21% of married Social Security recipients and 43% of single recipients rely on their Social Security benefits for at least 90% of their income. In 2019, the median debt for senior households totaled $31,050.
Going back to the workforce is often the only viable option for many older adults who do not receive sufficient income from their pension and government benefits. But retirees are less likely to find jobs in the current market, and there are also challenges of limited mobility, transportation, and health problems that keep them from going back to work. Fortunately, those with sufficient equity in their home have other options available to them through a reverse mortgage loan program.
How can a reverse mortgage can help you budget your retirement income?
A reverse mortgage is an extremely useful financial product that can help homeowners increase their cash flow and live the rest of their lives in comfort. The biggest benefit of a reverse mortgage is that it provides retirees with a substantial amount of money while allowing them to continue living in their home–so long as they meet ongoing requirements.
Regardless of your financial situation, a reverse mortgage is an ideal solution for effectively budgeting your retirement income–especially if you are still paying your forward mortgage loan. In addition, you have complete control over where your money goes since there are no limitations on how you can spend your loan proceeds.
The sample budget below highlights how a reverse mortgage can help you budget your retirement income:
| Before Retirement | After Retirement | Retirement with Reverse Mortgage | |
|---|---|---|---|
| Income | $6,000 | $4,000 | $4,000 |
| Mortgage Payment | $2,500 | $2,500 | $0 |
| Car Loan | $400 | $400 | $400 |
| Credit Cards | $300 | $300 | $300 |
| Groceries | $350 | $350 | $350 |
| Gas | $150 | $150 | $150 |
| Utilities | $100 | $100 | $100 |
| Healthcare | $300 | $300 | $300 | Left Over | $1,900 | -$100 | $2,400 |
Assuming you wish to lead the same kind of lifestyle post-retirement, it is clear that eliminating your monthly mortgage payments can better allow you to meet your needs. A reverse mortgage can help increase your cash flow to cover expenses such as healthcare costs, ongoing homeownership expenses, or home modifications.
There are, of course, plenty of alternatives if you no longer have the income to make your monthly payments and live the life you want after retirement. For example, you can:
- Downsize
- Move-in with a family member or friend
- Refinance your existing loan
- Use your retirement savings
- Withdraw from your life insurance policy
Each of these options has pros and cons, but in many cases the advantages of a reverse mortgage make it the best choice.
Take this scenario for example:
Linda is a 65-year old former corporate manager who used to make $5,000 a month. After retirement, her private and federal pension plans pay her about $3,500 a month. However, she still has to pay her traditional mortgage loan at $1,500 a month for the next five years. Along with her mortgage, her living expenses (food, utilities, insurance, maintenance, transportation, etc.) leave her with little to no cash left over every month.
If she were to encounter a medical emergency, she would likely have to use a large portion of her income to pay for medical bills, which can cause her to miss her monthly mortgage payments. Unless she can bounce back quickly, she is at great risk for delinquency and eventual foreclosure. Unfortunately, this scenario is very common for many older adults in the United States.
Before such an emergency happens, Linda can opt to take out a reverse mortgage loan, having already built substantial equity in her home. Even if her income stays at $3,500 a month with the loan, eliminating the $1,500 mortgage payment leaves a lot of breathing room for other expenses. More importantly, it can allow her to prepare for unexpected costs in the future. She doesn’t have to move out, sell her home, modify her loan, or drain her life savings if something were to happen.
What financial issues can a reverse mortgage help solve?
To summarize, here are the potential financial issues that a reverse mortgage can help minimize or eliminate:
- Lack of money for basic needs; inadequate income
- Difficulty paying off an existing traditional mortgage
- Unexpected expenses
- Exhausted retirement savings
- Risk of foreclosure or bankruptcy (as long as the homeowner is still able to meet their loan obligations)
- Outstanding non-mortgage debt
- Lack of cash reserves
In short, a reverse mortgage can provide homeowners financial stability–all while allowing them to stay in their home for the rest of their lives.
What are the requirements for a reverse mortgage?
You are eligible for a traditional reverse mortgage loan if you meet the following criteria:
- You are 62 or older
- Your home must be your primary residence for the life of the loan
- You meet the home equity requirements of the type of loan you’re applying for
- You are financially capable and willing to meet property tax, homeowner’s insurance, and maintenance obligations
- The proceeds from the reverse mortgage must eliminate the debt from your existing traditional mortgage if you have one
What are the different types of reverse mortgages?
Single-purpose reverse mortgage. You can only use this loan for one purpose, such as home repairs, property taxes, or upgrades. It is the least expensive option but is not available everywhere. Usually, homeowners with low to moderate incomes can apply for this type of loan.
Proprietary reverse mortgage. This type of private loan allows you to access your home equity through a private lender. The customers of a proprietary reverse mortgage are usually homeowners with homes valued above the Federal Housing Administration’s limit, which is $822,375. Homeowners aged 55-62 may be eligible for this program, depending on which state the borrower resides in.
Home Equity Conversion Mortgage (HECM). A HECM loan is the most common type of reverse mortgage loan. This type of loan is federally-insured and backed by the U.S Department of Housing and Urban Development (HUD).
You can use the proceeds from a HECM loan for any purpose. The maximum amount of money you can borrow with a HECM or proprietary reverse loan depends on:
- Your age. The older you are, the more money you can borrow.
- The appraised value of your home. The higher the appraisal, the more you can borrow.
- Current interest rates. The lower the mortgage rate, the more money you can borrow.
- A financial assessment of your willingness and ability to meet your ongoing obligations to the house and the loan.
- The type of reverse mortgage you choose.
Bottom line
A reverse mortgage loan is a complex financial tool that requires adequate research and complete understanding. While the benefits of a reverse mortgage are apparent in this article, it pays to be fully informed before making a major financial decision, especially while in or nearing retirement.
Talk to us at South River Mortgage today to learn more about reverse mortgages, find out if you qualify for a reverse mortgage, and determine which type of mortgage is best for you. Our dedicated reverse mortgage specialists will be happy to assist you with any questions or concerns.