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Fear of COVID infection at nursing home facilities has many senior Americans, and their families, evaluating other options.
As of February 2021, more than a third of the country’s COVID-related deaths occur within long term care facilities.
Many are turning to reverse mortgages to help pay for in-home care as an alternative. This helps explain why 2020 data from industry tracker, Reverse Market Insight reflects a 34.8% year over year increase in reverse mortgages.
With a reverse mortgage, instead of making a monthly home loan payment, the equity built up over time could pay homeowners, giving them extra money for retirement costs, long-term care, or other goals.
Reverse mortgages are one option for homeowners to get cash out of their homes – but it isn’t the only one. A home equity line of credit can help seniors cover expenses without driving up a loan balance from monthly home equity payouts.
Financial experts told us to proceed with caution. “It’s important to have all the facts,” says Warren Ward, a financial advisor at WWA Planning and Investments in Columbus, Indiana. While reverse mortgages can be the right move for some seniors, others may get more value with a home equity line of credit (HELOC) or by selling their house outright, says Ward.
Determining the right path forward starts with understanding how reverse mortgages work and weighing the pros against the cons.
What Is a Reverse Mortgage?
A home equity conversion mortgage – also known as a HECM, or more commonly as a reverse mortgage – allows homeowners to draw money out of their home’s equity. As opposed to a traditional mortgage, where homeowners make monthly payments to the bank, lenders in a reverse mortgage make a monthly payment to the homeowner as part of a loan against their home equity.
How Do Reverse Mortgages Work?
Under a traditional mortgage, a lender agrees to grant a mortgage to a homeowner, using the home as collateral. Over 15 or 30 years, homeowners make a series of equal payments to their financial institution, agreeing to pay the interest ahead of the loan balance. Once the loan is complete, the buyers have full ownership over their home and can take advantage of the full equity held in the home.
With a reverse mortgage, the lender agrees to give the homeowner equal monthly payments based on the value of their home. In turn, the homeowner effectively ‘sells’ a portion of their equity to the lender over time, while interest accrues on the loan balance. At the end of the loan – either through selling the home or the passing of the homeowner – the balance of the reverse mortgage loan becomes due.
For example, a homeowner agrees to a reverse mortgage with a $1,500 payout per month at an interest rate of 3%. The lender agrees to pay the owner $1,500, which is added to their loan balance. With every month that passes, an additional $1,500 adds to the loan balance, and the interest is continually charged.
Once the homeowner exits the home, they (or whoever inherits the home) would be required to pay back every $1,500 payment made to the homeowner, plus interest. This can be achieved by selling the home, rolling over the reverse mortgage into a traditional mortgage, paying off the balance from a life insurance policy, or surrendering the home to the bank.
Reverse Mortgage Pros
For those who have built up home equity over time or have paid off their mortgage, reverse mortgages could make sense. Under the right circumstances, reverse mortgages can help seniors stay in their home while providing them additional funds to cover living expenses.
The biggest benefit of a reverse mortgage is getting access to cash from the value of your home. For some, the payments of a reverse mortgage allow them to defer collecting Social Security and get larger monthly payments, while others use the money to augment their fixed-income budget for long-term healthcare needs.
“A reverse mortgage helps you get your equity out and utilize it for various needs,” says Chuck Czajka, a financial planner and owner of Macro-Money Concepts in Stuart, Florida. “It frees up a little cash flow for them, which is one of the biggest benefits.”
You don’t have to move
Another key benefit of reverse mortgages is that owners can live in their home without the burden of a monthly home loan payment. In certain situations, it may be more cost-effective to go through a reverse mortgage than to sell the existing home, shop for a new one, and ultimately move.
Money from a reverse mortgage is not taxable
Because reverse mortgages are still loans, the income homeowners receive is not taxable and may not affect Social Security or Medicare benefits. On the other side, the interest that accrues on the loan is also not tax-deductible until you start paying on the loan, which could affect how much you pay every year. Before entering a reverse mortgage, be sure to talk to a tax professional to determine how you may be affected.
Debt cannot exceed property value
Real estate markets can fluctuate over time, and there is a risk that any home could lose value over time. If the reverse mortgage balance exceeds the fair market value, the homeowner and their families cannot be held responsible for the excess. Because reverse mortgages are considered “non-recourse” loans, the lender can only collect debt equal to the home value.
You continue owning the home
In addition to allowing individuals to keep living in their homes, a reverse mortgage allows homeowners to keep ownership of their real estate. Reverse mortgages are not due until the owner passes on or decides to sell the house, giving families plenty of time to decide what to do with the home in the future.
Reverse Mortgage Cons
Although there are some positives to a reverse mortgage, they also come with notable downsides for homeowners and their families. Alongside building debt against the asset, reverse mortgages can also come with high costs to open the loan and ultimately prevent foreclosure.
Reverse financing cost
All mortgages come with a number of closing costs, including origination fees, appraisals, and home inspections, attorney and title fees. Depending on the home and type of reverse mortgage, closing costs alone can exceed $20,000.
Moreover, homeowners will also be responsible for paying many of the fees that were once part of their monthly mortgage payment. Out of the monthly reverse mortgage payments, homeowners must budget for quarterly property taxes, home insurance, and any dues to the homeowner’s association.
Your home can still be foreclosed
One of the most common misconceptions about reverse mortgages is that a lender can’t foreclose on the property because they pay the homeowner to live there. However, if the homeowner fails to pay property taxes, keep an acceptable home insurance policy, or pay regular HOA fees, the bank reserves the right to start foreclosure proceedings.
A reverse mortgage is still a loan, and interest will build on every payment to the homeowner. Even at a low rate, interest is applied monthly to the balance, ultimately cutting further into the home’s equity. Before agreeing to a reverse mortgage, be sure to understand the amortization table to see how much interest the homeowner or their family could be responsible for.
Because reverse mortgages can significantly affect a family’s finances, the FHA has very strict guidelines on who can get a loan. Homeowners must be at least 62 years old, own a significant stake in their home, and must live in it as their primary residence. In addition, they must meet with an FHA-approved counselor to go over their finances and determine if it is the best option for their situation. If homeowners don’t meet the requirements, they won’t be able to qualify.
Should the homeowner’s status change – such as moving from the house to a long-term care facility, or getting remarried – the terms of their mortgage may change. Before moving forward with a reverse mortgage or major lifestyle change, be sure to consult an attorney and financial professional to determine how your reverse mortgage may be affected.
Is a Reverse Mortgage Right for My Family?
Taking out a reverse mortgage is a serious decision for any family, and should not be entered into without careful thought. While these loans can help seniors live out their golden years in their own home, it can also create bigger problems down the line for their family.
Before starting down the path towards a reverse mortgage, families should assess their sequence of returns from their retirement funds. If there’s a major market change that could affect the value of the homeowner’s savings, or a change in health requires additional care, a reverse mortgage could make sense.
“One scenario we see is that people want to stay in their home, but they are getting pinched by taxes going up, or their health care costs are rising,” says Ward. “This is where we would consider a home equity conversion mortgage – picking up positive cash flow helps them stay in their home longer.”
Conversely, taking out a reverse mortgage can create significant problems for the homeowner’s family. Once the individual with the loan passes away, their partner and heirs could be left with a difficult decision on how to pay the balance.
“If a home is in one spouse’s name and they die, the loan is called immediately,” says Barb Pietrangelo, a financial planner for Prudential based in Ada, Michigan. “Additionally, family members who are left to deal with the property will also likely face accruing fees and interest.”
Before investigating a reverse mortgage, experts say families should sit down and look at all the available options. A home equity line of credit or other estate planning options, like annuities, could provide better avenues to make cash available.
Senior care plans can be a difficult decision. From a purely financial perspective, many experts agree the cons of a reverse mortgage outweigh the pros, and only consider reverse mortgages as a last resort.
Be sure to discuss your financial picture and goals with a professional, to see what makes the most sense for all stakeholders.