Reverse mortgages are increasingly popular because they put extra money in your pocket. But they’re only suitable for a small number of people so don’t rush into one before you know if it will really help your financial situation.
A reverse mortgage is just what it sounds like: The lender pays you, rather than you paying the lender. Essentially, you’re taking out a loan against your home equity that doesn’t have to be repaid until you move out of the home or die.
One of these loans could be right for you, or a family member, if:
- Income is fixed.
- Additional money is needed to live on.
- A home is the only major asset and estate plans don’t call for it to be left to heirs.
Here’s a tip sheet with five factors to weigh when considering a reverse mortgage:
1. How it works. Typically, the loan is repaid from your home equity when the home is sold, either after you move out or you die. When your home is sold, the loan is repaid and you or your heirs receive any leftover home equity. But while the loan is outstanding, you still own the home and don’t make any monthly mortgage payments. You must also continue to maintain insurance and property taxes.
2. The mechanics of the loan. Reverse mortgages are “non-recourse loans,” which means that what you owe can never exceed the selling price of your home. If it does, the government or the lender makes up the difference. These mortgages are also “rising-debt loans” — the interest (which can be fixed or variable) is added to the principal each month. The interest owed increases significantly over time because of compounding and it cannot be deducted from your taxes until you pay off all or part of the loan.
3. Who qualifies? You must be at least 62 and own your own home, although you may be eligible if you are still paying down a first or second mortgage. There are no income or medical requirements. Reverse mortgages are available for most properties except mobile homes and co-ops. The money can be used for anything. However, if your home needs repairs to qualify for the loan, part of the proceeds must be put aside for that purpose.
4. How much money you receive. The loan amount depends on your age, the type of reverse mortgage, the value of your home, current interest rates and where you live. In general, the older you are and the more valuable the home, the larger your loan. You can receive your proceeds monthly, in a lump sump or as a line of credit that you can tap into whenever you need the money.
5. Tax implications. Your payments are tax-free because the IRS considers them a disbursement of principal, not income.
Note that the housing law enacted in 2008 offers greater protection for homeowners considering reverse mortgages. Among other changes, the law caps origination fees and prohibits lenders from requiring the purchase of a financial product as a condition for the reverse mortgage.
If you, or someone you know, is house rich and cash poor, a reverse mortgage may be an option to boost cash flow. But the loans are complex and a home is a valuable asset, so check with a financial advisor who can help you minimize the risks.
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