Certified financial planner Wes Moss provides personal finance advice and accessible investment strategies. His guest post appears here weekly.
I’m getting a lot of questions these days about “reverse mortgages,” which offer a way to unlock the equity in your home without selling it. The mounting interest in this topic speaks to the desperation many Americans feel as they struggle to fund increasingly long retirements.
In order to qualify for a reverse mortgage you must be 62 or older, own your home, have equity in that home, and can never have defaulted on a government loan. In addition, you must receive Home Equity Conversion Mortgage counseling before the loan can be consummated. The purpose of this last rule is to ensure you understand the unusual nature of the commitment you are making with a reverse mortgage.
The amount you can receive in a reverse mortgage heavily depends on your age. The older you are, the larger the percentage you will be allowed to “borrow” from your home. For example, say you are in your late 60s, your house is worth $250,000 and your mortgage is paid off. A reverse mortgage lender may loan you approximately $155,000 with a 5 percent interest rate.
That money, which is tax exempt, is now yours to use. But, like the proceeds of any loan, it must be paid back to the bank, along with interest. In this example, the interest would run about $7,750 per year. You don’t make monthly payments. The money is due when you die or sell the home. Whoever inherits your house becomes responsible for any remaining balance on the reverse mortgage.
Reverse mortgages aren’t cheap. Based on my research, our example loan would cost the borrower about $12,000 in closing costs, including origination fees and required insurance coverage. That’s almost 8 percent in closing costs, compared to the 1-2 percent you might expect to incur when closing a traditional mortgage. Interest rates for reverse mortgages are steep, too – currently just north of 5 percent. And remember – your loan balance goes up every year, not down, as interest accrues.
In my opinion, reverse mortgages should only be taken as a last resort for those in desperate need of retirement income. A reverse mortgage might allow you to stay in your home for the rest of your life (assuming you are able to keep up with taxes, insurance and condo owner fees.) And, unlike a home equity loan, a reverse mortgage can’t be randomly cancelled on you. But, again, reverse mortgages are expensive to obtain and pay off.
Think carefully and get lots of advice before signing on this particular dotted line.
– By Wes Moss, for Atlanta Bargain Hunter