Reverse Mortgages for Retirees in Debt: Too Good To Be True?

You’ve heard the adage that if it sounds too good to be true, it probably is – but reverse mortgages might just be the exception to that rule. The trick is to be informed.

It’s a fact of life that many Americans have no plan for retirement. Some sources say up to 50 percent of wager earners have nothing in savings. With the cost of living going up, and social security checks covering less and less, it’s getting harder for some seniors to make ends meet. For people age 62 and older, a reverse mortgage might be an answer to prayer.

Reverse Mortgage Myths

One of the most common misconceptions about a reverse mortgage is that it’s free money. It’s not. A reverse mortgage might be the opposite of a traditional mortgage, ergo the lender will pay you, but let’s call a spade a spade. It’s a loan. It might not be one where you have to write a monthly check to pay a lender back, but it will eventually have to be paid back … one way or another. Think of it as a piggy bank, one that holds all of your home’s equity. You can easily access that equity, but once it’s gone, it’s gone, and you’re going to pay to use it.

Some seniors worry that, upon their deaths, their heirs will be responsible for the debt incurred. The truth is that you will be expected to make good on your loan either upon your death, when you sell your home, or if you no longer use the home as your primary residence – this includes nursing homes (although you are allowed to reside in a medical facility for up to 12 months before the loan must be repaid). No ifs, ands, or buts about it, banks expect to make money on the interest they charge. If you borrow against all the equity in your home, it goes without saying that you’ll have no equity to pass on to your heirs.

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Another fear is taxes, but take note: According to the Federal Trade Commission Consumer Information page on Reverse Mortgages, the loan advances are not taxable. Nor should they affect your Social Security or Medicare benefits, the site says.

Types of Reverse Mortgages

Not all reverse mortgages are created equal, although they should all work in about the same way. The difference varies in interest rates, origination fees, and the amount you will be allowed to borrow – similar to a traditional loan.

A federally insured reverse mortgage – or a Home Equity Conversion Mortgage (HECM) – is one of the most popular. It has safeguards in place to ensure seniors are reasonably protected. An HECM will have a “non-recourse” clause geared toward protecting consumers from ever owing more than the amount of equity in their home. Federal law also requires that consumers applying for an HECM must meet with a counseling agency. Origination fees affiliated with the loan are dictated by law. You should never be charged more than those federally mandated fees.

Not all reverse mortgages are federally regulated, however. A single purpose reverse mortgage is different than an HECM. So is a proprietary reverse mortgage. Both types of loans are offered by private entities – some are good, some are bad. Do your research before signing on the dotted line.

Whatever type of reverse mortgage you receive, it’s important to remember that just like any other traditional loan, you will still be responsible for property taxes, insurance and maintenance fees. Don’t fall for a sales pitch that you’ll be payment free–you won’t.

Show me the money

So you’ve made your decision and you’ve decided to go with an HECM, that is, a reverse mortgage backed by the U.S. Department of Housing and Urban Development (HUD). You’re probably curious about how you’ll receive your money. HUD makes that easy for consumers to understand. According to their web site, borrowers may receive payments in the following way:

  • Tenure: Equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.
  • Term: Equal monthly payments for a fixed period of months selected.
  • Line of Credit: Unscheduled payments or in installments, at times and in an amount of your choosing until the line of credit is exhausted.
  • Modified Tenure: Combination of line of credit and scheduled monthly payments for as long as you remain in the home.
  • Modified Term: Combination of line of credit plus monthly payments for a fixed period of month selected by borrower.
  • Single Disbursement Lump Sum: A single lump sum disbursement at mortgage closing.
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As you can see, a reverse mortgage affords seniors a variety of options to receive payments. They are ideal for things like home improvements, or, if you find yourself in a pinch. If you decide to sign up for one, be certain to ask your lender how to cancel the loan should you have a change of heart.

A reverse mortgage loan might well be an answer to prayer, but be advised they can quickly eat into your home’s equity. You might well be left holding that empty piggy bank. And don’t forget that you’ll still be responsible for things like property taxes and insurance. Do your research, and don’t fall for a too-good-to-be-true sales pitch.

Pamela Britton-Baer is a staff writer for SuperMoney. Her mission is to help fight your evil debt blob and get your personal finances in tip top shape.