Although reverse mortgage can improve your retirement income, there are a lot of things you need to know before getting a reverse mortgage. A reverse mortgage is one of the best ways retirees can generate extra income without making extra loan payments. Since it is a major financial decision, you have to know what you will get before getting yourself committed to it.
What Is A Reverse Mortgage?
A reverse mortgage also is known as the Home Equity Conversion Mortgage (HECM) is an FHA-insured program, and it has existed since 1988. Its creation aims to give retirees an added income creation option. A reverse mortgage is opposite to a traditional mortgage. In a traditional mortgage, a lender receives money from a homebuyer over time, and a reverse mortgage is the opposite of this. This means that the homeowner will borrow money from a bank to acquire equity in a home.
Is A Reverse Mortgage For Everyone?
Reverse mortgages are not meant for everybody. Four specific conditions need to be met before being eligible for a reverse mortgage.
- You must be up to 62 years old.
- You must have a home that conforms to HUD standards. This means that buildings and co-ops with four housing units or more are ineligible.
- You must have equity that will justify the reverse mortgage in your home.
- The first lien holder must be the reverse mortgage lender.
How Reverse Mortgage Works
A reverse mortgage works in different ways when you get one; these ways depend mainly on how you will get paid. Below are six different payment ways offered when you purchase HECM reverse mortgages:
- Term: There are equal payments for a fixed number of months.
- Tenure: This provides equal monthly payments provided that a borrower is still living in the property.
- The line of credit: Just like HELOC (home equity line of credit) and it makes it possible for people to make use of their reverse mortgage to borrow money if they need it.
- Modified Tenure: This is a combination of the tenure option and a line of credit.
- Modified term: This is a combination of the term option and a line of credit.
- Single disbursement lump sum: This is a single payment that is paid to the borrower(s) at closing.
For the lump sum payments, they are done at a fixed interest rate while other options come with variable rates. Your age, the appraised value of the home, and the current market interest rates are the factors that determine the amount of money you can get. However, before they start processing a loan, the borrowers will take a counseling course where they will explain to them how reverse mortgages work, tax and financial implications and other things they need to know.
How The Balance Grows
The way balance grows is based on a simple calculation, let’s assume a reverse mortgage which was obtained as a lump sum with a fixed interest rate. If you are 62 and obtain a reverse mortgage of $100,000 at 5% interest (in addition to the mortgage insurance) and the current value of your home is $300,000, your balance will grow according to the years since origination and how old you are growing. You will have a balance of $128,336 at 67 years and $446,774 at 92 years with 5 and 30 years since origination respectively while assuming monthly compounding. Since you never owe more than your home’s value, you climb up rapidly over time.
Tax Implications
Generally, the IRS considered a reverse mortgage as a loan advance and not as a taxable income. Borrowers cannot deduct the interest charged each year on a reverse mortgage unlike in a traditional mortgage. However, for those who itemize deductions, the mortgage insurance premium charged taxes on these deductibles. Since they are not taxable income, they do not affect Medicare benefits or Social Security. But since proceeds are known to be liquid assets, they can affect SSI and Medicaid eligibility.
Beware Of The Costs
Reverse mortgages are not cheap, and an average borrower should expect the payment of more than $11,000 in fees (in addition to other closing costs) on a reverse mortgage of $100,000 as of 2018; this is according to the NRMLA (National Reverse Mortgage Lenders Association). Before starting a reverse mortgage, you need to compare its costs to other borrowing options as another option may be better.
In conclusion, a reverse mortgage is a better option for those who do not have other ways to get money to live their life and to cover expenses. When thinking about the benefits, think about the drawbacks too like the cost and the long-term loss of your home equity. You can go for a reverse mortgage if the pros are more than the cons.
