Many Americans struggle to make ends meet during their retirement. A third of all retirees now get 90 percent or more of their income from Social Security, according to figures from Boston College's Center for Retirement Research. For those who are fortunate enough to own their homes, a reverse mortgage can be an option that can supplement Social Security and other income sources.
Reverse mortgages get their name from the fact that the stream of payments goes the opposite direction from what homeowners are used to. Rather than you making monthly payments to your bank, the lender sends the money back to you.
It's a simple way for retirees to tap their home equity without the risk of a conventional mortgage or having to sell their homes and move to less expensive housing. But before you decide it's right for you, you need to understand exactly what you're getting into.
Here are five facts that are essential to know for anyone considering a reverse mortgage.
Fact 1: Reverse Mortgages Have Different Payout Options.
Reverse mortgages offer a variety of different options for you to tap your home equity. The Federal Housing Administration offers reverse mortgages with five different payment plans. One option involves taking equal monthly payments that run as long as one borrower remains alive and lives in the home as a principal residence. You can also choose a fixed term of years, after which time you'll stop receiving monthly payments even if you're still living in the home. A flexible line of credit is also available, giving you the option of choosing how much and when to take money out, up to the maximum amount of the line.
In addition to those three options, you can combine lines of credit with the first two monthly-payment options. These two hybrid options allow you to use a portion of the available funding for a line of credit and receiving the rest through either of the two monthly-payment options.
Fact 2: Reverse Mortgages Only Offer a Portion of Your Home Equity.
Reverse mortgages don't give you access to the full equity you have in your home. Rather, the FHA calculates the maximum mortgage amount based on the age of the youngest borrower, current interest rates, and the appraised value of your home.
You also have to pay the costs of a reverse mortgage, including mortgage insurance premiums, third-party lender charges, and origination and servicing fees. Many lenders will work those costs into the loan amount they make available to you, reducing your net proceeds even further.
Fact 3: You Can Lose Your Home With a Reverse Mortgage.
Many aggressive reverse-mortgage lenders falsely state that retirees can't lose their homes with a reverse mortgage. While reverse mortgages do offer some protection to homeowners, they still require you to keep up your end of the bargain, and there are dire consequences if you don't.
Among the responsibilities of reverse-mortgage borrowers include paying for utilities, homeowners insurance, flood insurance, and real-estate taxes. Most lenders will keep a close eye on whether you keep up with those responsibilities, and if you don't, the lender can take action on the loan, with options that include foreclosure. The FHA has seen up to 70 percent of borrowers take out large lump sums in recent years rather than using the monthly payment option. Those retirees can quickly use up the money, and find themselves unable to handle the costs of keeping up their home.
Fact 4: It Matters Who's Listed on the Reverse Mortgage.
Recently, many families have gotten into trouble with reverse mortgages because they listed only one owner as the borrower. The benefit of doing so is that choosing the older member of a couple can boost your monthly payment or allowable loan amount. However, the much larger problem is that the guarantee that you'll be allowed to remain in your home as long as it's your primary residence extends only to named borrowers, not to spouses or family members. As a result, in situations in which the named borrower has died or entered a long-term care facility, lenders have foreclosed on surviving spouses who weren't listed on the reverse mortgage.
Fact 5: There are Disreputable Lenders Out There.
Weak property values and increasing complaints about reverse mortgages have led to many lenders choosing to stop making the loans available. Bank of America (BAC), Wells Fargo (WFC), and MetLife (MET) have all exited the market in recent years, and smaller mortgage brokers and lenders have taken their place. While some of those smaller lenders are reputable, others can push you into loans that make it difficult for the borrower to even afford the maintenance and other costs they're required to pay under a reverse mortgage.
Know the Terms
Reverse mortgages can be a valuable tool to help retirees make ends meet, but they can also be extremely dangerous and put your home at risk. Before following through with a reverse mortgage, make sure you understand its terms and shop around to get the best deal you can. Ideally, the best way to make sure you're making a smart decision is to make the effort to find an adviser who doesn't have a vested interest in getting you to take out the reverse mortgage.
Get more information about reverse mortgages from the Department of Housing and Urban Development's website.
You can follow Fool contributor Dan Caplinger on Twitter @DanCaplinger. Dan owns warrants on Bank of America and Wells Fargo.The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Bank of America and Wells Fargo.
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