Reverse mortgages tend to have a bad rap, but in reality, they are the perfect solution for some homeowners. This mortgage allows you to tap into the equity in your home and take it out as cash. You do not make payments on the loan; however, the loan must be paid off at the final sale of the home. The most common borrowers to inquire about this loan program are elderly people that have stopped working and do not owe any money on their home. This means they own their home free and clear and might be in a bind because of the fixed income they receive from the government and/or their pension. The reverse mortgage can provide these borrowers with the extra cash they need to live comfortably; however, the loan does come with its own risks, so only a select few should actually act upon the benefits of this loan.
Are you Financially Responsible?
The first question to ask yourself is whether or not you are financially responsible. This is because you could receive your funds in one of three ways:
- Lump sum
- Periodic payments
- Line of credit (like a credit card)
That being said, it is easy to see how someone that was not financially responsible could get in over their head. Let’s look at an example. Let’s say Fred took out a reverse mortgage of $100,000. His home is worth $200,000 at the time. He receives the money in a lump sum and goes on a spending spree. He fixes things up in the house, but also uses the money for frivolous things. One year later, the values in Fred’s neighborhood drop dramatically; he now only has $25,000 equity left in the home after the reverse mortgage gets paid off and he was counting on that money to help his relatives at the time of his passing. Now Fred has left his family in over their heads.
If on the other hand, Fred was more responsible and only used the money for things he really needed, such as important maintenance on the home that he could not afford or his property taxes that his income does not cover, he would not be so in over his head. He would likely still have money left over in the account and if the values did drop, he could easily pay back the reverse mortgage with the money he did not touch, leaving his relatives in a much better predicament upon his passing or even himself in the near future, if he planned to move.
Why do you Need the Money from a Reverse Mortgage?
If you have established that you are financially responsible, the next step is to figure out why you need the money. Is it for day-to-day living? If so, this probably is not the best choice. Yes, you earned the equity, but living day-to-day can get quite expensive, especially if you are still on the younger end and do not have health issues. What do you do when the money runs out? You are left with no day-to-day living expenses and now you have very little if any equity left in your home. Your better option would be to sell the home and live off of the equity, finding a less expensive living arrangement to help you stay financially fit.
On the other hand, if you need the money for things like property taxes or one-time major expenses, it can be worthwhile. You know that you are only using the money for these things and will leave the remaining equity untouched. Even if you need money for your property taxes for several years down the road, knowing that the money is strictly for those purposes can help you stay on track and not get in over your head down the road.
How will you Take the Money?
The method you take the money out for the reverse mortgage plays a role in the amount you will receive as well as the interest rate the lender will provide. If you plan on taking a lump sum, you can plan on receiving the lowest mortgage amount as well as the highest interest rate as this is the riskiest type of loan for the lender. From there, the line of credit will provide you with the next highest interest rate because the amount of money you take out is the money you will pay interest on. If you do not end up needing very much money, the bank does not make very much on your loan, so they will charge a slightly higher interest rate than they would have charged if they were providing you with scheduled disbursements. The scheduled disbursements provide the lender with regular and scheduled profit, allowing them to provide you with the lowest interest rate. Depending on your age, how you plan on using the money, and the amount of equity in your home, the interest rate should play an important role in your decision.
How Long will you Stay in the Home?
The final determination to consider is how long you will stay in the home. Are you planning on moving into a retirement home or in with relatives as you get older? If this is going to happen within a few years, a reverse mortgage could really hurt the amount of money you have to live on once you sell the home. You need to think of the future implications of taking money out now. If there is a financial situation that is making you think you need to take out this loan, do not think of the here and now – think of the future so that you can determine the right choice for you.
The reality of the situation is that you need to think of the people that will inherit your home and what they will do with it upon your passing as well as your immediate future plans. If you have plenty of equity and need the money to stay in the home, meaning you need to pay for upkeep and taxes, a reverse mortgage could be a good idea. On the other hand, if you are going to use the money haphazardly, it could harm your loved ones and even you, in the end. Thinking long and hard not only about the reason you need the money, but the way it will affect you and others in the long run is the best way to look at the situation to determine if this mortgage product is the right choice.
Justin McHood is America's Mortgage Commentator and has been providing expert mortgage analysis for over 10 years.