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Fear of COVID infection in nursing homes prompts many older Americans and their families to consider other options.
As of February 2021, more than a third of COVID-related deaths in the country occur within long-term care facilities.
Many are turning to reverse mortgages to help pay for home care as an alternative. This helps explain why 2020 data of the industry tracker, Reverse Market Outlook reflects a 34.8% year-on-year increase in reverse mortgages.
With a reverse mortgage, instead of making a monthly home loan payment, the accumulated equity over time could pay homeowners, giving them extra money for retirement costs, long-term care, or other goals.
Reverse mortgages are one option for homeowners to obtain cash from their homes, but it is not the only option. A home equity line of credit can help seniors meet expenses without increasing the loan balance of monthly home equity payments.
Financial experts told us to proceed with caution. “It’s important to have all the facts,” says Warren Ward, financial advisor to WWA Planning and Investments in Columbus, Indiana. While reverse mortgages may be the right step for some seniors, others can get more value with a home equity line of credit (HELOC) or by selling their home outright, Ward says.
Determining the right path to take begins with understanding how reverse mortgages work and weighing the pros and cons.
What is a reverse mortgage?
TO home equity conversion mortgage – also known as a HECM, or more commonly a reverse mortgage – allows homeowners to take money out of their home’s equity. Unlike a traditional mortgage, in which homeowners make monthly payments to the bank, a reverse mortgage lenders make a monthly payment to the homeowner as part of a home equity loan.
How do reverse mortgages work?
Under traditional mortgage, a lender agrees to give a homeowner a mortgage, using the house as collateral. Over 15 or 30 years, homeowners make a series of equal payments to their financial institution, agreeing to pay the interest before the loan balance. Once the loan is complete, buyers have full ownership of their home and can take advantage of the full value of the property.
With a reverse mortgage, the lender agrees to give the owner equal monthly payments based on the value of your home. In turn, the homeowner effectively “sells” a portion of his equity to the lender over time, while interest accrues on the loan balance. At the end of the loan, whether through the sale of the home or the death of the owner, the balance of the reverse mortgage loan matures.
For example, a homeowner accepts a reverse mortgage with a payment of $ 1,500 per month at an interest rate of 3%. The lender agrees to pay the owner $ 1,500, which is added to his loan balance. With each passing month, an additional $ 1,500 is added to the loan balance and interest is continually charged.
Once the owner leaves the home, he (or whoever inherits the home) must return each payment of $ 1,500 made to the owner, plus interest. This can be accomplished by selling the home, renewing the reverse mortgage on a traditional mortgage, paying off the balance on a life insurance policy, or handing over the home to the bank.
Reverse Mortgage Pros
For those who have built up home equity over time or have paid off their mortgage, reverse mortgages might make sense. In the right circumstances, reverse mortgages can help seniors stay in their home while providing additional funds to cover living expenses.
The biggest benefit of a reverse mortgage is getting access to cash from your home equity. For some, reverse mortgage payments allow them to defer collecting Social Security and earn higher monthly payments, while others use the money to increase their fixed-income budget for long-term health care needs.
“A reverse mortgage helps you get your equity out and use it for various needs,” says Chuck Czajka, financial planner and owner of Macroeconomic concepts in Stuart, Florida. “It frees them up a bit of cash flow, which is one of the biggest benefits.”
You don’t have to move
Another key benefit of reverse mortgages is that homeowners can live in their home without the burden of a monthly home loan payment. In certain situations, it may be more profitable to go through a reverse mortgage than to sell the existing home, buy a new one, and ultimately move out.
The money in a reverse mortgage is not taxable
Because reverse mortgages are still loans, the income homeowners receive is not taxable and may not affect Social Security or Medicare benefits. On the other hand, the interest that accrues on the loan is also not tax deductible until you begin to repay the loan, which could affect the amount you pay each year. Before signing up for a reverse mortgage, be sure to speak with a tax professional to determine how you may be affected.
Debt cannot exceed property value
Real estate markets can fluctuate over time and there is a risk that any home will lose value over time. If the balance of the reverse mortgage exceeds the fair market value, the owner and their families are not responsible for the excess. Because reverse mortgages are considered “non-recourse” loans, the lender can only collect debt equal to the value of the home.
You still own the house
In addition to allowing people to continue living in their homes, a reverse mortgage allows homeowners to keep ownership of their real estate. Reverse mortgages do not mature until the owner dies or decides to sell the home, giving families plenty of time to decide what to do with the home in the future.
Cons of the reverse mortgage
Although there are some positives to a reverse mortgage, they also have notable downsides for homeowners and their families. In addition to creating debt against the asset, reverse mortgages can also have high costs to open the loan and ultimately avoid foreclosure.
Reverse financing cost
All mortgages come with a series of closing costs, including origination fees, home appraisals and inspections, attorney and title fees. Depending on the home and the type of reverse mortgage, the closing costs alone can exceed $ 20,000.
Additionally, homeowners will also be responsible for paying many of the fees that were once part of their monthly mortgage payment. Outside of the monthly reverse mortgage payments, homeowners should budget for quarterly property taxes, home insurance, and any Homeowners association.
Your house can still be foreclosed
One of the most common misconceptions about reverse mortgages is that a lender cannot foreclose on the property because it pays the owner to live there. However, if the homeowner fails to pay property taxes, maintains an acceptable home insurance policy, or pays regular HOA fees, the bank reserves the right to initiate foreclosure proceedings.
A reverse mortgage is still a loan and interest will accrue on each payment to the owner. Even at a low rate, interest is applied monthly to the balance, ultimately reducing your home’s equity even further. Before accepting a reverse mortgage, make sure you understand the amortization table to see how much interest the owner or their family could generate.
Because reverse mortgages can significantly affect a family’s finances, the The FHA has very strict guidelines about who can get a loan. Homeowners must be at least 62 years old, own a significant interest in their home, and live in it as their primary residence. Additionally, they should meet with an FHA-approved counselor to review their finances and determine if it is the best option for their situation. If the owners do not meet the requirements, they will not be able to qualify.
If the owner’s status changes, such as moving out of the home to a long-term care facility or remarrying, the terms of your mortgage may change. Before going ahead with a reverse mortgage or major lifestyle change, be sure to consult an attorney and financial professional to determine how your reverse mortgage may be affected.
Is a reverse mortgage right for my family?
Obtaining a reverse mortgage is a serious decision for any family, and should not be made without careful thought. While these loans can help seniors live their golden years in their own home, they can also create bigger problems for your family down the road.
Before embarking on the path to a reverse mortgage, families should evaluate the sequence of returns on their retirement funds. If there is a major change in the market that could affect the value of the homeowner’s savings, or a change in health requires additional attention, a reverse mortgage might make sense.
“One scenario that we see is that people want to stay at home, but taxes are going up or health care costs are going up,” says Ward. “This is where we would consider a home equity conversion mortgage – getting positive cash flow helps them stay in their home longer.”
On the contrary, obtaining a reverse mortgage can create significant problems for the owner’s family. After the person with the loan dies, your partner and heirs may have to make a difficult decision about how to pay off the balance.
“If a house is in the name of one of the spouses and he dies, the loan is requested immediately,” he says. Barb pietrangelo, a Prudential financial planner based in Ada, Michigan. “Additionally, family members who are left in charge of the property will also likely face accrued fees and interest.”
Before researching a reverse mortgage, experts say that families should sit down and weigh all the options available. TO home equity line of credit or another estate planning optionsThey, like annuities, could provide better avenues for disposing of cash.
Senior care plans can be a difficult decision. From a purely financial perspective, many experts agree that the disadvantages of a reverse mortgage outweigh the advantages and only consider reverse mortgages as a last resort.
Be sure to discuss your financial picture and goals with a professional to see what makes the most sense for all stakeholders.