As more and more baby boomers retire, the consideration of a reverse mortgage has become relatively common. Although reverse mortgages have been around for years in various formats, the reverse mortgage, or the Home Equity Conversion Mortgage (HECM), from the Department of Housing and Urban Development (HUD) is the main program available today.

Check your home buying eligibility. Start here (Sep 16th, 2024)

Reverse mortgage basics

A reverse mortgage is so-called because the homeowner receives payments from the reverse mortgage lender instead of the other way around when the homeowner makes mortgage payments to the bank.

These payments are derived from the home’s current equity and provide tax-free income as a lump sum, monthly payments, line of credit or a combination of available options. Reverse mortgages are available with fixed or adjustable interest rates.

There are no credit score or income requirements as the homeowners do not have to make any payments but are only obligated to keep the property insured and property taxes current.

For a complete guide to reverse mortgages, see our blog post.

When a reverse mortgage makes sense

Many aging home owners can find themselves “house rich” but “cash poor.” Maybe not “poor” in the literal sense as much as not being able to access the equity in their home without obtaining a home equity line of credit or selling the home outright.

A home equity line of credit is certainly an option to tap into home owner equity but the home owners must qualify for the new loan as well as make monthly payments to the lender each month.

A reverse mortgage allows home owners to transform the equity in the property into tax-free cash in the bank. However, there are some considerations to undertake when evaluating a reverse mortgage, so let’s look at a couple of scenarios.

Reverse mortgage scenario I

A couple has owned their home for 27 years and is valued at $550,000. Jerome, 71 and Wanda, 69 are both retired and receive pension income as well as social security. They have approximately $78,000 in a cash account and $110,000 in various IRAs. They do not have any long term care insurance and are considering in-home assisted living service when they need it (reverse mortgage borrowers must remain living in the home). They own their home free and clear, the property taxes are $4,000 annually and the insurance premium is $2,750 per year.

They don’t have enough funds to cover the costs associated with assisted living services and long term care insurance at their age is not feasible. Jerome and Wanda explore a reverse mortgage option.

If they choose the fixed rate program, the lump payout is $268,400. The Standard ARM and Saver ARM have different payouts due to the lower upfront cost of mortgage insurance required for the Saver product.

Now let’s change a variable and have Wanda be a sprite 62 years old. The new reverse mortgage amounts are:

In this example, simply by adjusting Wanda’s age, the various loan amounts will change. In addition to their current retirement assets, a reverse mortgage will pay them $251,900 in one lump sum, less closing costs, more than enough for in-home assisted living expenses.

Reverse mortgage scenario II

Carl and Betty have little saved up for retirement and depend upon social security for monthly expenses. They have a small mortgage balance of $48,000 and pay $352 per month to their lender and still have eight years left before the home is paid off.  The home’s value is $290,000 and they would like to eliminate their mortgage payment. Both are 64 years old. They would like to pay off their current mortgage, obtain funds to make repairs on their home and have a line of credit available to them to use as needed. Their scenario looks like this:

Depending upon their selection, their maximum payout will vary, less the existing mortgage and closing costs.

Don’t forget the reverse mortgage closing costs

Neither scenario includes numbers for estimated closing costs so don’t forget to deduct those charges from the reverse mortgage amount. Closing costs will be deducted at the settlement table. Those fees include the mortgage insurance premium paid at the settlement table of 2 percent of the home’s value, which is by far the most expensive fee associated with a reverse.

Lenders can also charge an origination fee of up to 2 percent of the first $200,000 of the home’s value plus an additional 1 percent on amounts over that. In addition, there are standard closing costs including appraisal charges, settlement, and recording fees.

Why get a reverse mortgage?

There are a host of reasons to consider a reverse mortgage but the primary motivators are to keep the home, tap into the home equity that is income-tax free, and in many cases eliminate a mortgage payment.

If you’re evaluating at reverse mortgage options for you or your parents, take your time and get your questions answered well in advance. The program is more complicated compared to a traditional mortgage but when it works, it can offer a peace of mind that other retirement options simply can’t provide.

Check your home buying eligibility. Start here (Sep 16th, 2024)

*figures from ibisreverse.com