Pros and Cons of Reverse Mortgages

One of the fastest growing products in the home finance industry allows borrowers to transform their home equity into cash, use it to finance their retirement and pay it back when they move out of their home. The product is called a reverse mortgage but you must be at least 62 years old to qualify.

The loan money can be dispersed in several ways including monthly payments, an equity line of credit or a one-time payout. The amount available to borrow depends on the borrower's age, the value of the home, interest rates and loan fees.

Reverse mortgages originated in the 1960s but the public has been hesitant to use the credit source. The reverse mortgage market is a fraction of the mortgage industry, comprising only about seven-tenths of 1 percent of the market as a whole.

Today, their popularity is steadily on the rise and although many borrowers praise them, not everyone agrees they are a good idea. Converting equity into cash can help boost the financial bottom line when earning potential is limited. They can be a valuable retirement tool but homeowners need to understand them and use them properly.

Reverse mortgages are very profitable for lenders. Upfront costs are paid to the lender out of the home's equity at loan closing. Lenders also make money through interest, origination fess and points. The interest rates depend on the market but the closing costs are significantly higher than with conventional mortgages.

An additional cost to reverse mortgages is the burden of mortgage insurance. Mortgage insurance is usually required for regular mortgages where a borrower's down payment is less than a certain percent of the purchase. It protects the lender in the case of a default.

With a reverse mortgage, lenders depend on the property's value at the loan's end to be reimbursed. It also covers the lender if the reverse mortgage is held over a long period and accrued interest exceeds the value of the home.

The good news is that any appreciation in value that is over the amount due on the loan and interest remains the profit of the homeowner or their heirs. There is no difference between conventional and reverse mortgages in this aspect.

One aspect that is a serious consideration for reverse mortgage borrowers is that depending on where they live the loan proceeds could disqualify them for Medicaid. The loan proceeds count as an asset while untouched equity up to $500,000 does not. This affects Medicaid eligibility.

Another downside to reverse mortgages that borrowers often fail to recognize is that the terms of the loan often mean homeowners are pushed out of their homes after a certain period of absence, like a nursing home visit. The full loan balance plus interest becomes due when the house is vacated even if the owner intends to return home after rehabilitation.

This plays a part in the emotional impact of cashing out a home's value in later life. Homeowners might feel the vacancy terms of their reverse mortgage as an impending pressure. Another emotional consideration is the possible trauma of a homeowner parting with their home's value, something they may have viewed as part of their estate and meant for their children.

The benefits of a reverse mortgage can give seniors a financial boost that can be used for home repairs or medical expenses. The fact that the loan isn't due until the home is vacated can be a comfort to some borrowers.

However, there are other options that borrowers should investigate before tapping into their home's equity. One option seniors should consider is refinancing with a traditional 30-year fixed loan. This gives the homeowner the cash they need without excessive upfront fees.

This option comes with the burden of monthly loan payments but eliminates the fees for mortgage insurance, which can add up. Conventional mortgage payments can be more manageable because they are over a longer period of time. It can be more difficult to qualify on a limited income, but the option is worth researching.

Seniors should also investigate other options in their community that may help them over a financial hurdle. Many power companies have programs with low-cost financing for mechanical system improvements. The National Council on Aging has local branches throughout the nation and is another resource for seniors. Many programs and grants are available for seniors to improve and maintain their homes.

Objective counsel is available and a good idea. Seniors should seek an advocate other than just family members or caretakers, someone who doesn't stand to gain from their financial decisions. Family members may encourage a reverse mortgage to avoid responsibility of financing an elderly parent's care. They might also advise against a reverse mortgage with hopes of inheriting the property with its value fully intact.

Using a home's equity in retirement may or may not be a wise decision based on a case-by-case basis. A reverse mortgage may make sense for some borrowers, while others may find better solutions. Ultimately, the question of how to spend the equity in a home is personal and depends on individual needs. Before making a decision, homeowners should seek advice from multiple trustworthy sources, do their homework and ask a million questions.