This story originally appeared on NewRetirement.
For many people nearing retirement age, home equity is often the single largest component of net worth. It can be a valuable contributor to retirement and financial well-being — especially during this pandemic and time of monetary strain.
You can tap home equity by downsizing, securing a reverse mortgage or getting a home equity loan. However, the economic conditions might make this a particularly interesting time for a reverse mortgage.
A reverse mortgage is a type of loan for homeowners age 62 and older. Unlike a traditional “forward” mortgage, reverse mortgages do not require monthly payments toward the loan balance. And, reverse mortgages can pay off existing mortgages and eliminate monthly mortgage payments.
However, as you tap into your home equity, the loan balance grows. Borrowers repay the loan balance when they sell the home or move out — usually using the proceeds of the sale of the home.
Following are some pros and cons to review before considering a home mortgage.
Pro: You can stay in your home
Having the confidence that you can stay in your home is more important now than ever before.
With a reverse mortgage, you retain homeownership and the ability to live in your home. You must keep up insurance, property taxes and maintenance for your home, but it is yours to live in as long as you want.
Pro: Home values have not fallen
The more your home is worth, the more money you can tap with a reverse mortgage loan.
Home prices in most areas have been historically high recently, but it is unclear whether home prices will remain strong or not.
A recent report from Fannie Mae projected that though home sales would fall by 15% in 2020 due to issues with both supply (not many houses for sale) and demand (few buyers), home prices would remain stable. However, many experts predict that the severe downturn in the economy will eventually cause home values to fall.
Acting now might lock in a higher loan amount than you could get next year.
Pro: Interest rates are very low
Interests rates are another factor that impact eligibility and how much money you can get from a reverse mortgage. Interest rates also impact how much the loan will cost you.
Low interest rates mean you are eligible for more money at a lower cost.
Pro: It can be a good hedge
None of us know what is going to happen in the future. How long until we are fully out of quarantine, or until people find work again?
Having access to money can be a good hedge against uncertainty. And a reverse mortgage can give you that kind of option. Furthermore, a reverse mortgage line of credit can make the loan more appealing.
A line of credit is a source of money that is made available to you by a financial institution, which can be an excellent backup source of funds.
Pro: Line of credit grows, protecting you from falling home prices
In addition to being a great safety net option, other key benefits to a reverse mortgage line of credit include:
- Growth: Your untouched reverse mortgage line of credit can grow in value. Money in a reverse mortgage line of credit grows at the same rate as the interest accrued on the loan, including the .5% mortgage insurance premium. So, if the interest rate on your reverse mortgage is 4%, then your line of credit will grow at 4.5% (4% + 0.5%). This growth is unique to reverse mortgage lines of credit — a HELOC for example does not grow.
- Hedge against falling house prices: The growth in a reverse mortgage line of credit is guaranteed — without withdrawals, your line of credit is guaranteed to grow.
This feature can be an interesting hedge against the potential of falling home prices. If you think home prices will be stagnant or potentially fall, then a reverse mortgage line of credit allows you to lock in the current value of your home and continue to see your assets grow.
And you (or your heirs) will never have to pay back more than the home is worth.
Pro: Reverse mortgages are still available, whereas HELOCs are harder to get
Home equity lines of credit (HELOCs), which function as a cross between a home equity loan and a credit card, are currently difficult to secure. Banks are limiting access to these loans.
As of now, reverse mortgages are relatively widely available to eligible homeowners.
Pro: All of the other advantages of a reverse mortgage still apply
The main advantage of reverse mortgages is that you can eliminate your traditional mortgage payments and access your home equity while still owning and living in your home.
In good economic times and bad, the key advantages and benefits of reverse mortgages include:
- Flexibility: Use the money any way you want or need.
- Little downside: With a reverse mortgage you will never owe more than your home’s value at the time the loan is repaid, even if the reverse mortgage lenders have paid you more money than the value of the home. This is a particularly useful advantage if you secure a reverse mortgage and then home prices decline.
- Tax-free: As a reverse mortgage is a loan, the money from it is typically tax-free, whether you receive it as fixed income or in a lump sum.
- Federally insured: The Home Equity Conversion Mortgage (HECM) is the most widely available reverse mortgage. It is managed by the Department of Housing and Urban Affairs and is federally insured. This is important, since even if your reverse mortgage lender defaults, you’ll still receive your payments.
- Proprietary options: For higher value homes, there are several “jumbo” options available with higher lending limits and alternative fee structures.
Con: High fees
The upfront fees (closing and insurance costs and origination fees) for a reverse mortgage are considered by many to be somewhat high — higher than the costs charged for refinancing, for example.
However, the fees can be financed by the reverse mortgage itself, so there are options to avoid “out-of-pocket” expenses at closing.
Get more information on reverse mortgage rates and fees.
Con: Accumulating interest
There are no monthly payments on a reverse mortgage. As such, the loan amount — the amount you will eventually have to pay back — grows larger over time. Every month, the amount of interest you will eventually owe increases. However, the amount you owe on the loan will never exceed the value of the home when the loan becomes due.
Most reverse mortgage borrowers appreciate that you don’t have to make monthly payments and that all interest and fees are financed into the loan.
These features can be seen as reverse mortgage disadvantages, but they are also huge advantages for those who want to stay in their home and improve their immediate finances at their future expense.
Con: Not enough cash can be tapped
If you have a lot of home equity, you might be frustrated that a reverse mortgage only enables you to use some of it.
The HECM loan limit is currently set at $765,600, meaning the amount you can borrow is based on this value even if your home is valued for more. If your home is valued above this limit, then you may want to inquire about one of the “jumbo” proprietary options available.
Your actual loan amount is determined by a calculation that uses the appraised value of your home (or the lending limit above, whichever is less), the amount of money you owe on the home, your age and current interest rates.
Con: Reverse mortgages seem complicated
A reverse mortgage is a mortgage in reverse — that can be hard to get your head around.
With a traditional mortgage, you borrow money up front and pay the loan down over time. A reverse mortgage is the opposite — you accumulate the loan over time and pay it all back when you and your spouse (if applicable) are no longer living in the home. Any equity remaining at that time belongs to you or your heirs.
The basics of reverse mortgages can seem so foreign to people that it has actually taken many financial advisers and personal finance gurus some time to understand the product.
Many experts shunned the product early on, thinking that it was a bad deal for seniors — but as they have learned about the details of reverse mortgages, experts are now more willing to embrace it as a financial planning tool.
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