Seniors have been hearing a lot about reverse mortgages lately. Home prices have recovered in most areas and access to loans is getting easier. Any homeowner who is age 62 and has at least 50% equity in their primary residence can potentially qualify. Home equity can be withdrawn using a reverse mortgage with no tax consequences. The loan will eventually be paid off from the sale of the house which typically doesn’t have tax implications. This is because of the special tax treatment of capital gains related to the sale of a personal residence.
The proceeds from a reverse mortgage can be taken in several different ways:
- Lump sum – Withdraw your equity at one time.
- Monthly payments – Be on the receiving end of a mortgage payment.
- Periodic payments – Establish a line of credit that can be drawn on as needed.
Adding a reverse mortgage to your retirement plan can open up opportunities for other strategies. IRAs can be converted to Roth IRAs to minimize your required distributions at age 70 ½. Drawing Social Security benefits can be delayed until age 70 which will allow the benefit to grow. Investment accounts can be allowed to grow longer before being accessed for income. A reverse mortgage could also be used as a type of bridge loan to allow downsizing a residence or moving to a retirement community.
This sounds like a wonderful retirement tool but it does come with a hefty price tag. A reverse mortgage is a nonrecourse loan which never has to be repaid except from the sale of the residence. Interest accrues while the loan is outstanding. The amount that has to be repaid can never exceed the sale proceeds of the residence. The borrower must keep the payment of property taxes, insurance, utilities and other expenses of maintaining the home up to date. Failure to do so could require that the reverse mortgage be repaid in full. This feature is the nonrecourse aspect of the loan and it is paid for through mortgage insurance. Mortgage insurance rates vary from .5% to 2.5%, depending on the amount of home equity and the amount borrowed.
There are the typical closing cost expenses associated with a conventional mortgage. These expenses all become part of the loan. All applicants for these mortgages must be interviewed by a HUD-approved counselor, for which there is also a fee. The counselor explains the cost and features of these loans and most experts agree that the cost of HUD counseling is money well spent. Agencies charge around $125 for the session. Borrowers can choose a variable or fixed interest rate for their loan. However, the variable rate generally allows a larger loan amount.
Candidates for a reverse mortgage should consider how long they plan to stay in their house. One of the main benefits of this mortgage is the nonrecourse feature that caps the total expenses at the sale value of the property. A senior who intends to stay in the home through the end of life expectancy may not be as concerned about expenses. The borrower cannot be evicted from the home or the property foreclosed because the expenses of the loan exceed the home’s value.
A potential borrower should consider their health as part of this decision. Having a long-term care insurance policy that covers in-home health care could help assure they would be able to stay in the home longer. A senior who has certain degenerative diseases like Alzheimer’s or Parkinson’s may not be a good candidate for this loan for health reasons.
A candidate should also consider carefully their ability to maintain the home long-term. Real-estate taxes, property upkeep, utilities, homeowner’s insurance, energy costs, repairs, and the list goes on. Inflation could double those expenses before the end of life expectancy. If there is doubt about the affordability of the home, downsize to a more affordable home first before considering a reverse mortgage.
Experts say the ideal candidate for a reverse mortgage is someone who plans to live in their home until death. They are in good health, in their later 60s or older, and have life expectancies of 15 or more years. The loan has the best chance of being a good deal for the borrower if they outlive the expected mortality and can stay in the home.
Think carefully and do your due diligence before you enter into this type of loan arrangement. There may be other less costly and less permanent solutions to your financial problems. For more information see “The Pitfalls of a Reverse Mortgage Might Outweigh Its Benefits”.
- Reverse mortgages typically don’t have income tax implications.
- Expenses are high and they accumulate over time.
- The best candidate is someone who is healthy, plans to stay in their home until death, and can afford to maintain their home.