It’s hard to find someone who hasn’t been impacted by our country’s retirement crisis. It’s a problem that’s affected all income levels. And it’s become a challenge for multiple generations within a family. Inadequate savings may be the cause of this dilemma. But several factors are making things worse.
A frightening report from the National Institute on Retirement Security found the average working household has barely any retirement savings. With pensions disappearing, an unsteady future for Social Security, and much longer lifespans, Americans are increasingly facing serious financial shortfalls.
Retirees without enough savings are being forced to consider other options. And this may include leveraging their largest asset — their homes. While there are several ways to tap a home’s equity, reverse mortgages have emerged as a popular option. But here’s why reverse mortgages may not be the answer retirees are desperately searching for.
What’s a Reverse Mortgage?
What does a reverse mortgage actually mean? Basically, it can help fill financial gaps by allowing you to borrow against your home’s value for cash. It’s an attractive option for cash-strapped retirees because you won’t incur monthly payments and you will still own the home.
Who’s eligible? You must be 62 or older, own your home outright (or only owe a small amount), occupy the property as your principal residence, have no federal debt delinquencies, and agree to participate in reverse mortgage counseling. You also need to have enough cash to cover ongoing home expenses like property taxes and homeowner’s insurance.
Once approved, you’ll be given the option to receive your money as a lump sum at closing, equal monthly installments, a line of credit as needed, or a combination of the two. It’s easy to see why struggling homeowners find reverse mortgages so appealing. But it’s an extremely risky and expensive way to access your home’s equity.
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The Cost of a Reverse Mortgage
A reverse mortgage can cost you more than other types of home loans. Why? Much larger upfront costs and higher interest rates.
Here’s a detailed breakdown of what you can expect:
- Origination Fee: An origination fee is what the lender charges you for making the reverse mortgage loan. A lender can charge the greater of $2,500 or 2% for the first $200,000. Plus, 1% of the value over $200,000. This fee is capped at $6,000.
- Mortgage Insurance Premium: Did you know most reverse mortgages are insured by the Federal Housing Administration (FHA)? FHA insures these mortgages as part of the Home Equity Conversion Mortgage (HECM) program. And that means you’re required to pay upfront mortgage insurance premium (MIP). If you borrow less than 60 percent of your initial principal limit for the first year, mortgage insurance will cost .5 percent of the home’s appraised value. But if you borrow more than 60 percent, mortgage insurance soars to 2.5 percent.
- Real Estate Closing Costs: The closing costs are similar to what you’d pay for a traditional mortgage.
- Reverse Mortgage Counseling: The HECM program requires that you participate in reverse mortgage counseling. A HECM counselor discusses eligibility requirements, financial implications, and offers alternatives. The U.S. Department of Housing and Urban Development (HUD) can help connect you with a HECM Counseling Agency. And the fee is usually around $125.
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Running the Numbers for a Reverse Mortgage
Ready to run the numbers? The National Reverse Mortgage Lenders Association has a Reverse Mortgage Calculator to help you get a more accurate picture of what to expect.
Here’s an example of a 62-year-old seeking a fixed rate HECM in Nashville:
Your home has been appraised at $200,000 and you’re looking for a $100,000 line of credit.
Initial loan interest rate – 5.060%
Plus: mortgage insurance – 1.25%
Initial total loan rate – 6.310%
Loan principal limit – $106,000
Less: financed items
Loan origination fee – $4,000
Mortgage insurance – $1,000
Other closing costs – $2,222.75
Net principal limit – $98,777
Lump sum cash – $56,377.25
Fixed-rate unusable funds – $42,400
Total fees – $7,223
Other Risks To Consider
In addition to being extremely expensive, reverse mortgages carry risks. For starters, a reverse mortgage can jeopardize your ability to leave an inheritance to your family. Why? Because reverse mortgages have steep upfront costs and high interest rates. This means a large portion of the home’s equity may be needed to cover those expenses.
Additionally, the loan needs to be repaid once the last surviving borrower dies. If your partner is not a co-borrower, they will be forced to move out or repay the loan once you die. Also, your lender can terminate the loan if you don’t pay property taxes, homeowner’s insurance, or you fail to stay on top of maintenance.
Home Equity Line of Credit: The More Affordable Option
A reverse mortgage can be an expensive and risky way to access your home’s equity. But it’s not your only option. A home equity line of credit or HELOC may be the smarter choice. HELOC is an open line of credit that allows you to borrow money against your home’s equity as needed. And the loan is repaid monthly based on how much you’ve borrowed and the current interest rate.
The Cost of a Home Equity Line of Credit
Because your home serves as collateral, and a lender’s risk is minimized, interest rates for HELOCs are generally lower than what’s available for a reverse mortgage.
Several calculators revealed someone with a good credit score (660-749) in Nashville is eligible for a $100,000 HELOC with interest rates ranging from 2.99% – 4.67%.
But what are the upfront costs for a home equity line of credit? The Consumer Financial Protection Bureau (CFPB) put together a helpful guide that includes a checklist to compare with your lender. Similar to a traditional mortgage, fees range from 2-5% of the loan. This includes things like the home appraisal, application fee, points, and closing costs.
HELOC is also an attractive option because your interest is tax-deductible up to $100,000. Plus, you’ll avoid costly mortgage insurance.
Why a Reverse Mortgage May Not Be Worth It
The financial services industry has worked hard to promote reverse mortgages. But they’re not an ideal solution because they are overly expensive and risky. Luckily, reverse mortgages are not the only option for accessing your home’s equity. A home equity line of credit can help preserve your hard-earned asset. It’s far less expensive and may offer greater flexibility for your surviving family members.
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