Although many people work their entire lives so they can be financially secure during retirement, it doesn’t always work out that way. Especially in today’s low-interest-rate environment, lots of retirees are finding that their fixed-interest investments, such as bonds and certificates of deposit, aren’t returning as much as they had hoped.
So, many look for alternative ways to boost their retirement income. That’s where a reverse mortgage can come in handy. Retirees who own or are close to owning their homes outright often have a lot of equity but an inadequate income. A reverse mortgage can allow them to tap into that equity.
What is a Reverse Mortgage?
A reverse mortgage is a type of mortgage offered through traditional lenders that involves converting a portion of your equity into cash. It’s generally available to people 62 years old or older. One goal of a reverse mortgage may be to help retirees who are living on a fixed income pay off their debts. There is actually no restriction as to how a retiree may use these funds, but generally they are used for health care, living expenses or debt.
Types of Reverse Mortgages
There are three basic types of reverse mortgages:
- FHA Home Equity Conversion Mortgages or HECMs — This is a type of mortgage created by the U.S. Department of Housing and Urban Development. HECMs are issued by private banks but insured by the federal government. This type accounts for about 99% of reverse mortgages.
- Proprietary Reverse Mortgages — These types of reverse mortgages are among the least common, but it’s still important to mention them. These are non-FHA mortgages offered by private banks and lenders.
- Single-Purpose Reverse Mortgages — These loans are usually reserved for low- to moderate-income borrowers and offered by local governments or municipalities.
Why It’s Called a Reverse Mortgage
The reason why it’s called a reverse mortgage is because the lender’s and borrower’s roles are basically switched. With a traditional mortgage, you borrow money and make payments to your lender. But with a reverse mortgage, the lender makes monthly payments to you.
How Much Can You Get Out of a Reverse Mortgage?
There aren’t any hard and fast rules as to how much you can get from a reverse mortgage since the final amount will depend on a few things:
- The interest rate of your current mortgage.
- Mortgage insurance monthly premium, if applicable.
- Appraised value of your home.
- Age of the borrower — if there are two borrowers, the younger borrower’s age is used.
Watch Out for Fees
One thing to watch our for with a reverse mortgage is the fees. Before you decide on a reverse mortgage, take a close look at all the fees and closing costs. These fees can be steep, and some borrowers may be better served by taking out a home equity loan.
In addition, homeowners (and the title remains in the borrower’s name) still have home-related expenses, such as paying property taxes and keeping up the property. If you — or your parents — are interested in this kind of mortgage, it’s important to understand what the responsibilities will be and how to know if and when bills are due.
If you plan to stay in your home and would like to put the equity to work funding your life now, a reverse mortgage can be a valuable tool. It does come with some risks and responsibilities, though, and borrowers should clearly understand them.