|Gary Foreman is a former Certified Financial Planner (CFP) who currently writes
about family finances and edits
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I am almost 80 years old, a widow, excellent health, no debts, my
house is paid off, worth close to $200,000. I live on my social
security with a small savings backup, and I manage to make my taxes
and maintain a car and live well.
My children think I should take out a
reverse mortgage and spend the money doing some traveling. As they
are all doing well and do not expect or want me to just save the
house for them. Are there any pitfalls in this?
Yes, Betty, there are some pitfalls.
Any time that you put your home up to secure a loan there are
dangers. They may be reasonable risks to take, but you need to know
them. Let's take a moment to understand reverse mortgages. Then we
can better explore the risks and benefits.
A reverse mortgage seems strange at
first. The purpose of a reverse mortgage is to convert the equity in
your home into cash.
Like a regular mortgage, you're
borrowing against your home. And, when you sell you'll need to repay
any balance on the mortgage. But instead of borrowing all the money
at the beginning and then paying it back each month, this time
you'll borrow a little at a time and not repay the mortgage until
the house is sold. In that way it's the reverse of a traditional
Now the risks. The first problem is
that they're somewhat complicated. And that can be a real issue for
borrowers as they get older. Betty might understand everything
today. But it's not unreasonable to expect that she won't be as
sharp mentally in ten years.
Then there are expenses much like a
regular mortgage. Betty's house will need to be appraised. There
will be an origination fee.
If Betty does borrow against her
home, she needs to maintain enough equity for future needs. Her
monthly living expenses could increase faster than her income. Or
she might need to move into a nursing home. Her home is her only
significant financial asset. She needs to guard it's value
One payout option allows you to take
fixed monthly payments for the rest of your life. That does protect
you from losing your home during your lifetime. But it also means
that you'll only get the fixed income amount. And inflation can
shrink fixed income streams. The other disadvantage is that you
might not live that long. The mortgage company could be 'buying'
your house fairly cheaply.
Once Betty takes out a reverse
mortgage she can pretty much expect to have it until she sells the
home or dies. The reason is simple. She's unlikely to have enough
money to pay off the mortgage without selling the home.
So what are the benefits to a reverse
mortgage? A reverse mortgage would allow Betty to borrow against her
equity as often as she likes. She could borrow for a trip or any
unmet living expenses.
Since she's borrowing the money it's
not considered taxable income to her. That can make a reverse
mortgage better than selling stocks that have appreciated. Any stock
gains will trigger income taxes.
If Betty wants to get a reverse
mortgage she'll need to meet with a HUD approved counselor before
you can get a reverse mortgage. You'll find a list of approved
counselors at hud.gov.
Before she actually applies for a
loan and incurs those costs, Betty should compare the rates to other
sources of cash. The closer to age 62 the easier it is to find other
cheaper places to borrow.
Betty might want to check out
something called the "Home Equity Conversion Mortgage" (HECM).
It's a federally insured mortgage. For more information she can call
HUD at 1-888-466-3487
She'll need to decide whether she
wants a one time payout, the ability to borrow whenever she wants,
or a set monthly payout. Single purpose loans are generally the
least costly. But over 60% of homeowners choose to use a line of
credit type payout.
Ultimately the home will be sold. At
that time the value of the home will be broken into three parts: the
amount borrowed, the costs associated with that borrowing and
leftover equity that will go to Betty or her estate.
The best way to compare reverse
mortgages is to answer three questions about each mortgage. How much
money would you get? How much would it cost you? And how much equity
would be left when you sell or die?
Should Betty use a reverse mortgage?
A little travel sounds nice. But she might find a home equity loan a
little easier to manage than a reverse mortgage.