QUESTION:

What are the pros and cons of reverse mortgages?
“Needs to know.”

AFL’S ROSEMARIE BOYD ANSWERS:

Dear “Needs To Know:”

Before I give my opinion on this, I would like to start with a word of caution!   This decision is one which should not be made without expert advice!  Because much of the decision is a planning decision, you should seek the advice of a fee based financial planner in conjunction with an accountant.  These two experts will help navigate this very complex issue.

Let’s start by discussing who should NOT be thinking of doing a reverse mortgage, otherwise known as a Home Equity Conversion Mortgage.  People who have sufficient assets and income to meet their current and future needs, would have no need to take a step such as this.  It severely limits options in terms of flexibility for the future.  One exception might be to consider this option for transition financing if you are moving to a new location, but are having difficulty selling your home.  In this case, a reverse mortgage may be viewed as a financing option.  Once the house is sold, the debt is satisfied and the remainder of the appreciation is paid to the seller.

Under what circumstances is a reverse mortgage a reasonable option?

1.        This would be the option of last resort for someone who does not have sufficient assets or income to meet the day-to-day costs of living during the retirement years.

2.       If income is not sufficient to meet day-to-day cash flow needs and the only asset is the home, taking this step is a reasonable consideration

3.       If there is no benefit to downsizing and moving to a smaller home, and thereby pulling out equity.  This is especially true for those people who wish to remain in their current homes.

4.       One is not concerned about inheritance for children.

How does one begin to explore this option?

1.        Start with the major large conservative banks.  DO NOT CALL COMPANIES WHICH ADVERTISE THESE MORTGAGES IN THE MEDIA. Those companies pay their brokers a commission for every reverse mortgage that is placed.  This makes them not only a more costly alternative, but also leaves open the door for misrepresentation.

2.        Check with a major bank.  Our experience is that their representatives will approach this conservatively and are not likely to pressure you into an inappropriate decision.   At this point you are only gathering information and not making any decisions.

3.        Once you have gathered the information, take it to your financial planner to assist you in doing a review of your cash flow and future capital needs.  You may find that there are alternatives to the reverse mortgage.  Furthermore, before a client is approved for the mortgage, all banks will require the client to undergo some independent counseling to make sure that this step is appropriate, given the situation.

Things to be aware of when contemplating a reverse mortgage.

1.       These loans are non-recourse loans, meaning that if the value of your home drops and there is no equity left, the client is not responsible for coming up with any additional money.  HOWEVER, there is no free lunch!  For this protection, the client will be required to purchase an insurance policy which protects the bank.  These are costly and are wrapped into the closing costs.  This means that a reverse mortgage is not a good option for small amounts of money such as $20,000.

2.       Once you have a reverse mortgage, you will no longer make any mortgage payments.  HOWEVER, the interest is added to principal and the loan compounds monthly.  The rate is approximately comparable to that of a 30 year fixed mortgage.  What this means is that when you sell your house, the interest not paid to the bank.  It is computed into what the bank will take before you share in any additional appreciation.

3.       The loan amount available will vary depending on location (county), appraisal and the age of the youngest owner.  In order to be eligible for a reverse mortgage, the youngest owner must be at least 62 years of age.

4.       The interest rates do not vary a great deal among the major players.  One can expect normal closing costs for the appraisal and legal work.

5.       Even with a reverse mortgage, you still own your home and as such have the option to sell.   Should the home have appreciated in value, you will receive some of that benefit upon selling.

In conclusion, contemplating a reverse mortgage is a major life event which should not be rushed into and should be considered an option of last resort.

Rosemarie A. Boyd, CFP