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Pros And Cons Of Reverse Mortgages To Know Before Signing Up
A lot of folks trade down their houses or sell the current house to live in a rental when approaching retirement for the extra cash to live on.
While these actions can make total sense when things are put into perspective, it is not always a necessary step to take.
I get it.
Sometimes people no longer find a need to live in a big house as their kids have grown up and moved into their own homes. Trading down to a smaller house can be a logical step to take.
Sometimes homeowners feel that it’s time to reap the benefits of the equity accumulated in the house. They can release that cash by selling it, live a comfortable lifestyle from the sales proceeds, and just live in a rental.
But if you absolutely love the house or cannot imagine life in another home other than the existing one, a reverse mortgage could just be the perfect solution to solve your problems.
However, a big problem that reverse mortgage companies face is the negative connotations that go with it. In a way, this disadvantage is purely psychological.
An aging homeowner could very likely feel that he has spent decades paying off the house. And the thought of “reversing” that process can be met with a lot of resistance.
It should be stated clearly that if a homeowner who has trouble keeping up with living expenses feels that way about a reverse mortgage, he or she don’t really understand how this product works.
And just to offer some comfort, nobody will be forced out of their homes as federal law require these types of loans to be non-recourse. Meaning that a home’s value is the sole asset that can be tapped on to repay any outstanding debt balances.
In the unique event of a house’s value fall below the amount owed, lenders will absorb the losses.
The gist of all these is that reverse mortgages allow you to continue living in your home while using the equity in it as living expenses during retirement.
So what exactly is a reverse mortgage?
In the most simplest sense, such a loan arrangement would mean that a lender will send you a monthly check which you can cash in.
This is contrary to the traditional mortgage where you pay the bank! Can you now see why it’s called a reverse?
This recurring payment to you is a loan which is not taxable.
As the payments accumulate, the total amount is the outstanding balance due to the lender. And this debt will not require you to repay until the home is sold or if you move out.
As you can see from this simple borrowing structure, this is one of those credit products that actually has a heart. Even though the lender would be looking to make a profit, the primary objective is to allow the borrower to tap on the equity in his valuable house without having to sell it.
At this point, you might ask: Then how different is it from a typical home equity loan?
The key difference here is the assessment process for approval.
Equity loans will require personal income proof and a host of other documentation to evaluate the credit quality of the borrower.
This is not the case with a reverse mortgage which is a huge advantage. It’s not that income doesn’t matter. It’s just that they are not critical for approval. In fact, the difficulty of homeowners in qualifying for equity loans was a big reason why reverse mortgages were conceptualized in the first place.
Do you see why I described this as a loan with a heart?
How much can a borrower get?
This is a question that has no universal answers.
The amount a borrower will be able to get depends on a variety of factors including:
- Age of homeowner
- Value of property
- Interest rates
- Administrative and processing fees
Barring exceptional circumstances, a borrower would be able to get a higher amount the older he is, the more the house is worth, and the lower the interest rate.
Structure of loan
Before jumping into receiving monthly checks in the mail, consider other options of how the funds would be disbursed. There might be a better and more suitable manner in which to receive funds depending on individual preference.
1) Monthly payment
As stated previously, the most popular choice for borrowers to receive payments is via recurring monthly income.
However, take note that the amount you will get every month will depend on the quantum of loan you are eligible for. This implies that the longer you stretch the period to receive payments, the lower each payment will be. And vice-versa.
The drawback of this is that is can be tough to predict the best time frame suitable.
2) Line of credit
If you are not exactly in dire need of cash, a line of credit might be a better option to sign up for.
The benefit with this is that you have a source of funds that you can simply withdraw from by writing a check or going to the ATM.
A big advantage of such a credit setup is that interest does not kick in until you start owing money. And if you do not draw from the line of credit, you are essentially not borrowing yet.
3) Lump sum
Some people choose a lump sum payment due to certain financial commitments and obligations.
Bearing in mind that a reverse mortgage is supposed to serve those with financial needs in retirement, there are few instances where a lump sum payment can assist that purpose.
Nevertheless, this option will be available to a borrower.
If you’d like to have a little of everything, just make it be known to the lender.
Not all lenders allow mix and match of these loans. So do conduct a little research and obtain a few quotes to find the ones that do.
Alright I’m sold. What would it really cost me?
If you are in a position to consider a reverse mortgage, it is inevitable that you are someone who has lived a lot and has more wisdom than a young adult.
And surely you must know that lenders are profit-driven entities even when they try their utmost best not to look like one.
Here’s what a reverse mortgage will truly cost you.
As with all lenders that offer credit facilities, there is going to be an interest rate tagged to the loan. This can either be an adjustable rate or fixed rate.
Adjustable rate will move with market forces while fixed rates tend to be higher albeit offering stable and predictability.
2) Administrative charges
There are various types of fees that a lender can charge:
- Administrative fees
- Processing fees
- Disbursement fees
- Service fees
- legal fees
Different banks will have different levels of charges and different ways of labeling them. And they are usually deducted upfront before any money is disburse to your account.
3) Closing costs
On top of the variety of administrative fees mentioned above, a deal like this will also come with typical closing costs associated with real estate transactions.
- Local recording
- Agent fees
- Broker fees
- Home inspection
- Title insurance
A lot of businesses operate solely on serving the needs of consumers in regards to mortgages. This is where they get their payoffs.
If there are special terms, do read them up and understand what they really mean.
If you haven’t realized, a lender is taking on a huge risk in approving a reverse mortgage.
Usually bigger risks will come with bigger rewards. But this is not necessarily the case with such loans.
So it is inevitable that lenders would want to insure the investment they have made in you with relevant insurance policies.
The premiums will of course… be paid by you.
As you can see, there are some very big advantages of such mortgages. While most of the down side comes from the costs that you might incur.
However, I must say that these types of loans are perfect for retirees who are house-rich but cash-poor. And need a source of income to cater to their daily expenses as they are no longer generating sufficient income (if any) to get by.
If you are seriously considering a reverse mortgage and having reservations, you owe it to yourself to at least make some inquiries to understand them better and discover if it is a good fit for your circumstances.