With a tough economy, lowered social security benefits and weak retirement accounts, many Americans are turning to reverse mortgages for extra cash. A reverse mortgage is a special type of home loan that allows you to take a piece of the equity from your home and convert it into cash. No repayment is required until you no longer use the home as your principal residence (i.e. move or die).
According to Dr. James Gaines, research economist for the Real Estate Center at Texas A&M University, “Reverse mortgages are based on the home’s current value, borrower’s age and existing interest rates. Borrowers can choose to receive loan proceeds in a single, lump-sum payment, as periodic predetermined payments, a line of credit or both.” But before rushing into the lure of this “free cash” there are risks that need to be considered.
AARP offers up five questions to ask before considering a reverse mortgage:
1. Do you really need a reverse mortgage?
2. Can you afford a reverse mortgage?
3. Can you afford to start using up your home equity now?
4. Do you have less costly options?
5. Do you fully understand how these loans work?
Understanding the pros and cons of a reverse mortgage need to be considered before moving forward. The Real Estate Center at Texas A&M Unversity offers the following list of pros:
- A reverse mortgage has no fixed due date.
- No repayment is required as long as the home remains the borrower’s principal residence.
- Loans become payable upon death, sale, ceasing to live in the home or failure to keep taxes, insurance or maintenance current.
- Borrowers cannot be foreclosed on.
- Reverse mortgages are nonrecourse loans. The amount owed can never exceed the selling price.
- Borrowers continue to hold title to the property.
- There are flexible payment options.
- Loan proceeds are not taxable.
- Underwriting and approval do not depend on the borrower’s current income or employment status.
- Would-be borrowers are required to meet with an independent financial counselor prior to getting a loan.
- The lender’s lien on the property is removed if the lender fails to make loan advances according to the agreement.
Even though there are many positive aspects of the reverse mortgage, it isn’t always the right fix and there are many negatives associated with a reverse mortgage. Truly, reverse mortgages should not be entered into lightly and people thinking about moving forward with one, need to realize that when they die, whoever inherits the house will be responsible for paying off the reverse mortgage including all interest and costs associated with the loan. Also homeowners must be at least 62 years old and either have a high home equity or own the home outright. Reverse mortgages can be complicated since they are very different than forward purchase mortgages. Also these mortgages often require high up-front costs and borrowers will need to stay in the home longer to reap the benefits. Homeowners are still responsible for the home and all of the upkeep, maintenance, utility bills, insurance and taxes associated with it. Also, a home can still be foreclosed on if the homeowner ceases to live in the home for 12 consecutive months or defaults on taxes, insurance, etc.
Homeowners considering a reverse mortgage should weigh all of their options, consult with their family members, and understand the risks associated with any loan process.
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According to a June 15, 2010 CNN Money article, “The nation is simply not building enough homes to keep up with potential demand. Just 672,000 new homes were started in April, an annualized rate and less than half the long-term run rate needed to meet the nation’s natural population growth.” Along that same vein, Brian Wesbury, chief economist at First Trust Advisors said in an interview with Steve Forbes, “We need one and a half million houses per year just to keep up with population growth.”
Attaining a loan from a bank you already have a relationship with may seem like a logical first choice, and loyalty may have its rewards. Since some banks offer up enticements such as a small discount or an added benefit, your bank may seem to be the best option. If you have a savings or checking account with the bank and you have a great credit score, you will probably receive a competitive quote. You may find this to be easier said than done. The downside may be that without a shining financial record, you could have difficulty securing a loan at all. With the recent housing debacle, banks have tightened up their lending requirements. For example, an FHA loan only requires a credit score of 640, but the bank may require a better score in order to secure the loan. Also, most banks have a limited number of products available, and your bank may not have the right product for your specifications. Perhaps XYZ bank across the street may be waiting with the perfect loan for your buying needs, but you’ll never know about it because you are only dealing with YOUR bank.