In the wake of the global financial and credit crisis, many seniors are turning to federally insured reverse mortgages to tap into their home equity and, in some cases, to prevent foreclosure.
As the name implies, reverse mortgages enables a person who is age 62 or older to convert their home equity into an income stream without selling their home or losing ownership. The older the person is, and the larger the value of the equity in the home, the more money they can borrow.
Even though this market is a small portion of the overall credit market, demand for these types of mortgages among seniors and retirees has been steadily increasing. Many seniors and retirees who thought their retirement plan was on auto-pilot are now finding out they might not have the resources to weather this "perfect financial storm."
It should come as no surprise, since the credit market has dried up, the economy is recovering from a deep recession, unemployment is hovering around 10 percent, inflation is on the rise, and the stock and bond markets have caused the large majority of retirement savings plans to drop 40 percent to 60 percent.
However, even more surprisingly, this strategy is becoming increasingly common among the wealthy homeowners -- and often times for good reason. Instead of letting this equity sit in their home and provide no tangible value while the real estate market plunges, even the wealthy homeowners have found a variety of reasons to use this equity and cash. Sound and common strategies for the wealthy include using their home equity to pay the taxes due on converting a traditional IRA into a Roth IRA, purchasing second homes, distributing assets for estate planning purposes, gifting, purchasing insurance policies, funding grandchildren's college savings plans, or using the extra cash to travel, spend, and enjoy their retirement years more freely.
Although this can often be a sound strategy for many types of seniors and retirees, there are also some key issues to be aware of and possibly avoid. For example, because the fees are usually much higher than regular loans, this strategy should not be used unless there are plans to stay in the home for at least several years. Other big mistakes to avoid when using a reverse mortgage are spending the money too quickly or misusing the cash by investing the money into risky or illiquid investments.
Below are ten things I believe financial professionals should know and consider before using a reverse mortgage strategy:
1. Who owns the home?
Even though you are taking out a loan and cash from your house, because you are still the homeowner, you will continue to maintain ownership and full control of your home. In fact, the title will always remain in your name, and you can choose to sell the home any time you wish.
2. Can you lose the home?
As the homeowner, you can never be forced to move out of your home simply because you have a reverse mortgage. Of course, you must still make sure your property taxes and homeowners insurance are satisfied, and the house must also be your primary residence at all times. However, you do not have to repay this loan as long as you live in it.
3. Can you get a reverse mortgage if there is an existing loan?
Provided that the amount you can borrow is equal to or greater than the existing loan on your home, you can qualify for a reverse mortgage. In fact, using the equity or cash to pay off your existing mortgage is one of the most common uses of a reverse mortgage.
4. Can you end up owing more than the home is worth?
There are several safeguards for reverse mortgages, mainly the fact that these loans are always non-recourse loans. This means that a homeowner can never owe more than their home could sell for, and both FHA and Fannie Mae guarantee these reverse mortgage products.
5. Are there restrictions on how the money can be used?
Absolutely not! The most common strategies for using a reverse mortgage include:
6. What are the tax consequences?
- Paying off an existing mortgage
- Paying off credit card debt
- Paying for long term care
- Paying for health care
- Providing a security cushion
- Funding home repairs and improvements
- Purchasing a new car, boat, or second home
- Living a more comfortable lifestyle
- Helping your children with a down payment on their home
- Give to a church, university, or favorite charity
- Taking more vacations
- Helping children and grandchildren through gifting, college planning, etc.
One of the most attractive benefits of a reverse mortgage is that the proceeds are always received on a tax-free basis. The reason this is the case is simply because you are using the equity in your home to pay yourself now versus later.
7. Do you need a certain level of income or credit rating to qualify?
There are absolutely no income, asset, credit, or employment requirement qualifications when applying for a reverse mortgage. The reason this is the case is because there are never any repayments due on any portion of this loan as long as there is at least one homeowner, aged 62 or older, living in the home.
8. How will this affect your spouse, family, and inheritance?
As long as both spouses are aged 62 or older, listed on the deed of the home, and part of the reverse mortgage, there will never be a change in this program, even if one spouse should pass. The reverse mortgage only becomes due once all borrowers permanently leave the home, sell the home, or pass. Your family and/or your heirs will receive 100 percent of the value of the home, minus the value of the reverse mortgage balance at that time.
9. How much money can you receive?
The amount of money that is available to you depends on your age, the value of your home, and the current interest rate. Generally, the older you are, the lower the interest rate, and the higher the value of the home, the more money you can receive.
10. What options do I have to receive the cash?
A reverse mortgage provides many choices and options for receiving your money, such as a:
- Single lump sum cash payment
- Line of credit or a specific dollar amount
- Monthly payment for a specified period of time
- Monthly payment for as long as you live in your home
- Combination of these options above.
Also, payment options may also be changed upon request to reflect your changing needs. And remember, all of the options listed above provide you with the cash on a tax-free basis.
Other advantage of a reverse mortgages include the fact that you cannot lose your home, you can always pay off this debt any time you want to, and it does not affect you Social Security or Medicare in any way.
Like any strategy, it is not right for everyone, and you must be very careful with your choices with the cash. Also, you are required to discuss the decision, either by phone or in person, a counselor from a government-approved non-profit counseling agency.
Assuming this is the right fit, and the money is used properly, this can be both an effective and safe strategy for seniors and retirees to consider. By using a reverse mortgage, you always remain the homeowner with full control of your home, as well as have the ability to protect yourself against potential future housing market declines. Also, it is safe because the federal government stands behind this program and guarantees that you will receive all of your scheduled payments on a tax-free basis. Certainly food for thought, in my opinion.
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