Finding more ways to generate income can be the difference between “just getting by in retirement” and “retiring comfortably.” For those seeking an additional bump in monthly income — in particular, for those who reside in a home in which they’ve accumulated equity — a reverse mortgage is yet another potential option to generate this money.
In essence, a reverse mortgage allows you to take a part of that equity and turn it into cash — in the form of an advance or monthly payments to you, tax-free, and without the need to actually sell the house.
Of course, the flip side is that this transaction is a loan — that means it must be paid back at some point in time. That usually comes when the last homeowner passes away or you decide to sell your home (though you can always prepay without penalty). Thus, the biggest risk is that your home loses its value to the point that it is underwater to the debt.
With that in mind, let’s just take a general look at a few types of reverse mortgage:
Single-Purpose: Single-purpose reverse mortgages are offered by some state and local government agencies and nonprofit organizations, and can only be used for one designated purpose — for instance, to help pay for home repairs or improvements. That designation is specified by the lender.
Home Equity Conversion Mortgages: HECMs are insured by the Federal Housing Administration and are widely available through banks, and the money may be used for any purpose. They are also a bit more complex. Before applying for an HECM, you must meet with a counselor from an independent government-approved housing counseling agency. HECMs provide great flexibility, as you can choose from a number of income options, including a “term” option providing fixed monthly cash for a fixed time, a “tenure” option with monthly cash until you leave your home, a line of credit allowing you to draw down proceeds as needed, or a combination of monthly payments and the line of credit.
Proprietary Reverse Mortgages: These are private loans, backed by the companies that market them, with rules and regulations set up by each institution or lender. As such, they are not subject to government regulations.
While each of the three types of reverse mortgages contain different parameters, rules and costs, they are all aimed at providing you with cash based your age, the value of your home, the amount of debt you carry on the home, and current interest rates. Still, a few notes of caution apply:
- Fees can be expensive. Lenders generally charge origination fees, mortgage insurance premiums, closing costs and servicing fees. Find out how much you’ll be nickeled-and-dimed up front.
- Interest on the outstanding debt is added to the amount owed each month, so your balance increases over time! Make sure you understand how the interest is applied, particularly if your rate of interest is variable and tied to a specific index.
- Government-insured HECM reverse mortgages have “non-recourse” clauses, meaning you (or your estate) can’t lose more then the value of the home. However, the only way to retain the home is repaying the full amount of the loan.
- You still are responsible for all taxes, utilities, insurance and any other home ownership costs. If you don’t meet these obligations, the lender may be able to call your loan.
If you manage the process correctly — meaning you find a product appropriate for you through a legitimate source — reverse mortgages can be a solid source of income during retirement. However, I personally am not a fan of these products — they’re an expensive way to raise cash, and a scary way to lose what might be your last refuge (your home).
If you have your own hesitations, don’t be pressured by salespeople, or even friends and relatives. However, if you are interested, consult an adviser first.
This primer from the Federal Trade Commission’s Consumer Information office provides detailed information on the products and includes help numbers to find a list of counselors.
Marc Bastow is an Assistant Editor at InvestorPlace.com.