Economists continue to agree that homeownership can offer financial advantages throughout a person’s life. Along with providing homeowners a secure and reliable place to live, a home can also be used to obtain credit if or when financial emergencies arise. When people prepare for retirement, these monetary concerns may take on a whole new meaning as retirees realize that they no longer will receive a regular paycheck. If they want to secure their financial future by using the assets they already have in their possession, many senior citizens can choose to access the equity in their home and obtain a Home Equity Conversion Mortgage (HECM), otherwise known as a reverse mortgage.
However, before they apply for a reverse mortgage, it is critical that they understand precisely what this type of loan is and how it could impact their retirement. The idea of getting cash right now to bulk up bank accounts or pay off bills arguably seems very attractive to many seniors. But as any loan, certain terms and conditions could work to their disadvantage later. Getting the right reverse mortgage information and all of the facts before they apply can better help senior citizens make an informed decision and take the necessary steps to protect their financial standing both now and in the future.
Reverse Mortgage Definition
In its simplest terms, a reverse mortgage is a loan based on the amount of equity in a person’s home. The money from the loan can be used for whatever purpose the loan’s recipient chooses. This financing currently is only available to people who are aged 62 and older who own their homes. It is called a “reverse” mortgage because the stream of payments is literally reversed. Instead of clients making payments each month to the mortgage lender, the lender actually makes payments to borrowers.
The amount of money that people can receive through one of these mortgages can be dependent on a number of different factors. First, lenders typically consider the age of the youngest borrower. In many cases, the younger the borrower, the less money and lower interest rate the person can receive. Alternatively, older borrowers may receive more cash from their reverse mortgages, albeit at a higher interest rate. Second, lenders consider the overall condition of the house. A home in good repair typically qualifies for more equity value than a house that is older and has maintenance or repair issues that need to be addressed. People generally are not held to strict credit requirements because the loan is based primarily on the home’s equity. In fact, even credit challenged borrowers who otherwise would be turned down for a bank loan or traditional mortgage could qualify for this financing. These criteria all come into play when lenders consider whether or not to extend a reverse mortgage and how much money a borrower can actually receive.
Reverse Mortgage Requirements
Along with meeting the age requirements for this loan, people also must meet a few other criteria to be considered for this financing. They must own their home and use it as a primary residence. Homes that can be used for this purpose include single-family homes, condominiums, duplexes, town homes, and manufactured homes that meet FHA guidelines. A vacation home or a home that they own jointly with their children, for example, cannot be used for a reverse mortgage. Additionally, applicants must use this loan as their primary mortgage. Any other existing lien on the house must be paid off before applying or satisfied with the money they receive from their reverse mortgage.
In addition to the reverse mortgage being the primary loan on the house, people who receive this financing are also barred from borrowing against the equity with another lender. Homeowners typically cannot access the equity once this mortgage has been finalized. Understanding this condition can be vital to people who may experience a financial emergency later and want to take out a home equity loan on their home. With a reverse mortgage, their equity is already claimed and inaccessible to other lenders.
Unlike traditional mortgages that require people to make regular monthly payments, recipients of this financing can defer payments until they pass away or vacate the house entirely. They are not expected to make any payment on the loan and can live in the house without penalty or fear of eviction, all the while using the cash from the loan as they see fit. When the last owner of the loan passes away, the house will then be sold to satisfy the terms of the loan. Likewise, if the borrower moves out of or wants to sell the house, the home must be turned over to the lender and sold. These mortgage repayment terms explain why the home’s overall equity value outweighs a person’s credit score during the application process.
As with a traditional mortgage, the loan will accrue interest that will be added on monthly to the principle amount. The interest can be fixed or adjustable, depending on which one the borrowers qualify for or upon which the lender has agreed. It should be noted that reverse mortgages are not typically held to the same standards in terms of interest rates. The rates for an HECM may be substantially higher than a traditional mortgage.
As such, understanding the repayment terms can be especially crucial to people who perhaps thought to will the house to their children or grandchildren. If they receive a reverse mortgage, borrowers typically cannot will their home to anyone, but must instead be prepared for their house to be sold by the lender. If they change their minds and want to will the house to their next of kin, they must repay the loan before they die or move away; otherwise, the house must be sold according to the terms of the mortgage. It can likewise be important for people to disclose this fact to their heirs in order to avoid family conflict later. Children or grandchildren who hoped to receive the home as an inheritance could appreciate being informed of the reverse mortgage on the house. In some instances, heirs can pay off the loan for their parents or grandparents if they are adamant about keeping the home in the family.
Along with understanding the repayment terms of the mortgage, people who use this financing option should also understand what is expected of them as borrowers. Just as they would with any other type of mortgage, owners are expected to maintain a homeowner’s insurance policy for the duration of the loan. If they let their policy lapse or choose not to invest in this insurance, borrowers would be in violation of their reverse mortgage agreement.
Likewise, senior citizens with this mortgage are also liable for the taxes and upkeep of the home. The lender will not assume these obligations, but rather look to the borrower to maintain the safety and appearance of the home, as well as pay the annual taxes on the property. If people fail to comply with either of these expectations, they could risk legal action or seizure of their home by the lender.
Perhaps the biggest surprise to people who seek this financing, however, is the expectation that they will complete debt counseling prior to their being approved for their loan. This debt management class is now required of all reverse mortgage borrowers; lenders often will not review an application if people bypass this requirement. Some people may find it difficult to understand why they need this counseling, particularly if they are otherwise financially secure in their retirements. Even so, federal guidelines now mandate that people take this course prior to being approved for their reverse mortgage. The information in the course is designed to provide new information regarding debt, as well as helpful reminders about money management and retirement in general.
Financial Implications of a Reverse Mortgage
The actual process of applying for a reverse mortgage from start to finish can impact a senior citizen’s finances in unexpected ways. First, unlike traditional mortgages, it can actually cost more to process an HECM loan and require that people pay out more closing costs and processing fees than for what they may have been initially prepared. If they do not have the cash on hand right now to pay these fees, it could be advisable that they wait until they save that money. In many cases, the loan cannot be processed until those fees are paid up front.
However, aside from higher than average processing and closing fees, the financial implications from a reverse mortgage tend to be overwhelmingly positive. People who live on Social Security or SSDI are often held to tight standards when it comes to bringing more money into their household budgets. They often cannot work a part-time job or receive any other source of income without being penalized heavily by the Social Security Administration. When they take out a reverse mortgage, borrowers often do not have to report this money as income. The money is considered to be a loan, even if borrowers use it to bulk up their bank accounts or supplement their Social Security payments. They can receive this cash without being penalized by the government.
Likewise, borrowers who rely on Medicare also can receive one of these loans without fear of losing their health coverage. Many times, people who work part-time jobs or receive money from other source have to report the money as income and risk losing some or all of their Medicare coverage. With one of these mortgages, many Medicare recipients escape having experiencing any negative consequences, but instead can use the money for their intended purposes while still retaining their health coverage.
Along with avoiding negative implications on their Social Security or Medicare privileges, people also do not have to claim this money on their income tax returns. When they file taxes for the tax year in which they received their reverse mortgage, seniors are not required to claim the funds from the loan as a source of income. As with Social Security and Medicare, the IRS counts this cash as a loan and thus makes no claim to it when people file their returns. These financial advantages let people use the money without fear of having to pay expensive penalties or taxes on it later.
Moreover, people who apply for one of these mortgages also can rest assured that they will never owe more than the appraisal value of their home. In essence, they cannot be “upside down” with their mortgage and owe more money than what their house is actually valued at during the life of the loan. When the lender sells the house, any excess equity can be willed to people’s next of kin or used by the original borrowers if they are still alive and have relocated to a new residence. These benefits help borrowers avoid lingering claims to their estates and also could allow them to provide extra cash to their heirs if applicable.
In addition to avoiding fees and penalties, people who receive these loans also enjoy being able to retain the titles to their homes. They do not have to list the lender as a co-owner, nor do they have to file and request a new title from the state. Being able to retain the title to their house can put many borrowers’ minds at ease and help them avoid worrying about being evicted or forcibly removed from their residences. They can continue to live their lives and enjoy their retirements without having to look for alternative housing.
For many senior citizens today, retirement can be a time of both pleasure and worry. When they would rather focus more on enjoying their time with friends and family more than they would like to worry about their finances or having to take a second job, retirees could accomplish this by utilizing the equity in their homes. By taking out an HECM, or a reverse mortgage, seniors can get the money they need to pay bills, add money to their bank accounts, or enjoy in any other way they see fit. This type of financing can provide advantages that allow senior citizens to live comfortably throughout their retirements. However, before they apply for one of these loans, it can be crucial that they understand all of the requirements and conditions of this agreement. Being informed and knowing what reverse mortgages actually entail can help people make proactive and responsible decisions, as well as allow them to safeguard their finances now and in the future.