Whether you’re already retired or are approaching retirement, you’ve likely prepared for this stage in your life ahead of time. And while it feels like you’ve saved for retirement your whole life, many people find they are coming up short. Between rising costs of living and a higher life expectancy than years before, even the most strategic retirement plan can crumble, especially if you experience lifestyle changes, emergency situations or unexpected costs. But you may have an untapped resource that can provide additional money for your retirement plan. Have you considered your home equity?
For the first time in history, homeowners who are 62 and older now have a collective $7.05 trillion in home equity, according to the National Reverse Mortgage Lenders Association. It’s no surprise many are turning to their home equity as another financial resource to help fund their retirement.
So how can you tap into your home equity without leaving the home you love? A reverse mortgage may be able to help.
A reverse mortgage is another resource to add to your current retirement plan. In addition to Social Security, pension, 401k or other money you may have access to after retiring, a reverse mortgage has many loan options for tapping into your home equity. But before you use it to access your portion of that $7.05 trillion, make sure you understand what a reverse mortgage is and how it works to determine if it’s the right option for your retirement plan.
Let’s start with the basics.
What Is a Reverse Mortgage?
A reverse mortgage is a loan for homeowners who are 62 and older that allows them to convert a portion of their home equity into money that can be used for any reason. If you have an existing mortgage, you must use your proceeds to pay that off first, thus eliminating the required monthly mortgage payment. With a reverse mortgage, you remain the owner of your home, so you must continue to pay your property taxes, homeowners insurance, and home maintenance costs throughout the life of the loan even if you don’t have a mortgage payment.
While there are other types of reverse mortgages out there, including proprietary and single-purpose loans, the most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM). This type of reverse mortgage is a popular option because it is backed by the Federal Housing Administration (FHA) and is the only federally-insured reverse mortgage available. The HECM may be the best option for most people, but it has its limitations. For example, the loan has a max claim amount (or loan limit) of $726,525. If your home is worth more than $726,525, you may benefit more from a proprietary, or jumbo, reverse mortgage.
For the purpose of this article, we’ll stick to the HECM when talking about what a reverse mortgage is, how it works, and how you may benefit from one.
How Does a Reverse Mortgage Work?
A reverse mortgage works by using a portion of your home equity to first pay off your existing mortgage on the home, that is if you have a mortgage balance. You are not required to make monthly payments on the reverse mortgage because it doesn’t come due until the final borrower moves out of the home, passes away, fails to pay taxes or insurance, or neglects to maintain the home.
While you are not required to make monthly payments, doing so could reduce your monthly interest or prevent it from accruing altogether. If you choose not to make a monthly payment on the loan, interest for that month will get added to the total loan balance.
After paying off your existing mortgage, your reverse mortgage lender will pay you any remaining proceeds from your new loan. If you own your home free and clear, you’ll receive all of the proceeds from the loan since you do not have a mortgage balance to pay off first. As the homeowner, you get to choose how you want to receive your funds.
Getting Your Money
There are two types of HECM loan options: an adjustable rate loan and a fixed-rate loan. The adjustable rate loan has an interest rate that may increase or decrease throughout the life of the loan and offers more options on how to receive your proceeds. A fixed-rate loan has an interest rate that stays the same throughout the life of the loan and offers only one option for receiving your proceeds.
Depending on the type of loan you choose, you may receive your money in one of the following ways:
- Lump sum: With a lump sum payment, you’ll receive all of your money at once, in one large payment, when the loan closes. If you have a fixed-rate loan, this is the only way you can receive your money.
- Monthly term payments: If you choose term payments, you can decide how long you want to receive money from your reverse mortgage. The amount of money paid to you each month will depend on how long you choose to receive these monthly installments. For example, if you choose to get payments over the span of 10 years, you will get the same amount of money each month for 10 years, or 120 months. After that amount of time, you will not receive any more payments.
- Monthly tenure payments: With the tenure payment option, you’ll receive monthly installments that last throughout the life of your loan. Once the tenure payment is calculated, you’ll receive that amount of money each month for as long as you stay in the reverse mortgage. This option can help prevent you from outliving your reverse mortgage proceeds.
- Line of credit – By choosing the line of credit option, you can access your money from a line of credit whenever you need it. You’ll only pay interest on the amounts you actually borrow, and the money in your line will increase in value annually at the interest rate of your loan, just as it would in a checking or savings account. The line of credit also protects your equity because the value in your line of credit continues to increase even if the value of your home decreases.
- A combination of payment options: You can further customize your reverse mortgage payout by combining the different payment options. For example, you could do term or tenure payments in addition to a line of credit, so you still have access to more money if your monthly payment doesn’t cover your expenses for that month. Or, you could get a portion of your proceeds in one lump sum to pay off a debt or make a repair and put the remaining proceeds into a line of credit, or have them paid out in monthly installments.
No matter how you choose to receive your proceeds, they are not considered taxable income by the IRS. Instead, the IRS considers the money you receive a loan advance since the loan will eventually be paid back to the lender. That means you won’t be taxed on the money you receive from a reverse mortgage, nor will it affect your Social Security or Medicare benefits. To learn more about other benefits – like Medicaid or Supplemental Security Income – speak to your financial advisor.
Keeping Up Your End of the Deal
It’s important to remember that a reverse mortgage is still a loan and, as the homeowner, you still have responsibilities tied to the loan and to the home. While you don’t have to make monthly mortgage payments with a reverse mortgage, you’re still responsible for paying your property taxes and homeowners insurance. And, since the home is often used to repay the loan later, you must keep the home in good condition and complete any repairs and routine maintenance.
The home must also be your primary residence, so you must continue to live in the home for more than half of the year.
If you do not stay current on your taxes and homeowners insurance, fail to maintain the home, or live in the home for less than 6 months of the year, your loan may come due.
Paying Your Reverse Mortgage Loan Back
If you uphold the loan obligations listed above, your reverse mortgage will not come due until the last borrower moves out of the home or passes away. When this happens, the home is sold and the proceeds of the sale are used to pay the loan balance in full.
A reverse mortgage is a nonrecourse loan. That means, if the home sells for less than what is owed, you or your heirs will not be responsible for paying the difference. Depending on the type of reverse mortgage you get, the FHA or the lender will cover the difference and absorb the cost.
On the other hand, if the home sells for more than what is owed on the loan, the remaining money is given to you or your heirs.
If the loan comes due because you pass away and your heirs wish to keep the home, they can purchase the home for 95% of the home’s appraised value or the balance of the loan – whichever is lower. They can also refinance that cost into a traditional mortgage.
Reverse Mortgage Calculator: How Much Equity Can You Access?
Now that you have a better understanding of how a reverse mortgage works, you may be wondering how much you can get from the loan. Depending on the type of reverse mortgage you choose, you may be able to access up to 60% of your home’s equity. However, the actual amount of money you’ll receive from a reverse mortgage is based on the age of the youngest borrower, the amount of equity you have in the home, and the current interest rate. If you have an existing mortgage, you may want to subtract that amount from your total, since the lender will use that money to pay your mortgage off first. You may also want to factor in closing costs if you’d like to use some of your proceeds to pay those off as well, though they can be rolled into the loan balance, too.
To get a good estimate of just how much money you can get, use a reverse mortgage calculator. To get a more accurate estimate that takes your specific lifestyle and financial goals into consideration, call a reverse mortgage specialist.
Pros and Cons of Reverse Mortgages
A reverse mortgage can be a great financial tool in retirement, but it’s not always the right option. Learn some of the pros and cons of a reverse mortgage to help you decide if it’s the right financial choice for you.
Pros of a Reverse Mortgage
Depending on your needs and financial goals, a reverse mortgage may benefit you in the following ways:
- You remain the owner of the home. Your name stays on the title.
- You can access your equity without selling the home or paying a monthly mortgage.
- There are no credit score requirements at this time, though credit history will be reviewed during a financial assessment.
- You are protected from declining home values since it is a nonrecourse loan.
Cons of a Reverse Mortgage
Although there are a number of benefits that come with a reverse mortgage, the loan can also have some points that you will want to consider.
- Since you will be borrowing against the equity in your home, you will decrease your equity and increase your amount of debt.
- If you choose not to make payments, the loan balance will increase over time as interest accumulates.
- Depending on the type of loan you choose and how you handle your money, you may outlive your proceeds.
- While heirs will have a few options for keeping your home after you pass away, you may not be able to pass on the home to your heirs without a cost to them.
If you think a reverse mortgage may be right for you, here’s how to determine if you qualify for the loan.
Reverse Mortgage Eligibility and Qualifications
To be eligible for a reverse mortgage, you must meet the following criteria, at a minimum:
- You must be 62 years or older.
- You must have enough equity in your home – about 50%, but the required amount varies by lender.
- You must attend a HUD counseling session to learn more about the loan and your options.
- You must go through a financial assessment to ensure you are in the best position to be successful with your loan.
Along with these requirements, your home also needs to qualify for the loan. Here are a few basic requirements:
- The home must be your primary residence.
- The home must be in good condition and meet FHA standards.
- The home cannot be a manufactured or mobile home.
- If the home is a condo, it must be on the HUD/FHA approved condo list. If it is not, you may still be eligible for a proprietary reverse mortgage.
Applying for a Reverse Mortgage
First, we recommend you talk to your lender. They can assess your goals and talk about the best options for your situation.
After applying, you’re required to go through a third-party, educational counseling session. This is how the government ensures you fully understand the loan, your responsibilities and the repayment process.
When you apply for a reverse mortgage, you go through a process known as financial assessment. During this step, your lender looks at your income, credit history and assets to get a picture of your financial situation and determine whether or not you can comfortably meet the financial obligations of the loan.
If necessary, the lender will hold back part of your proceeds from the loan and put them in an escrow account to pay your property taxes and homeowners insurance for you.
Next, an appraiser will determine the value of your home. This helps the lender calculate how much money you’re eligible to receive. The final step is closing the loan in the comfort of your home. After that, you can access the funds after three business days.
If you’re interested in getting a reverse mortgage or learning more, you can get started here. If you would rather get started by talking to one of the specialists at One Reverse Mortgage®, you can give them a call at (888) 980-1543 and they’ll be happy to work with you.
What would you do with access to your equity? Share in the comments below!
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