Surveys suggest that the vast majority of seniors would like to stay in their own homes. Yet real estate is generally a family’s biggest asset, and not tapping into it can lead to a lower standard of living for the seniors involved, perhaps forcing them to sell earlier than necessary.
The way to get money out of a property without selling it is to borrow against it. But loans generally have to be paid, and the idea is to provide people on fixed incomes with more money, not less. When there is a market, a product will appear. Borrowing part of the equity on your house, then having the interest accrue with no payments due, is the theory behind the reverse mortgage.
Let us say, for example, that an elderly couple of small means has lived in an apartment for years. When the man dies, the woman finds that the life insurance she didn’t want them to pay for 30 years ago has paid her enough money to buy a condo in Florida near many of her friends. Her current income, however, will not allow her to pay the expenses to go with the property. Is she doomed to lonely life in the cold north, at the mercy of heartless landlords?
Not at all. First, she buys the property and moves. Then she takes out a reverse mortgage against it which is enough to pay her new expenses. The installments come every year, and the bank rolls the interest into the loan until she either pays it off or sells.
Reverse mortgages can take many forms. You can take a fixed payout, an annual or monthly payment, or establish a line of credit. In all cases the future interest becomes part of the loan, and you’re not required to make any payments. You do need to be at least 62 and actually live in the property that you are taking out the reverse mortgage on.
There are some very real drawbacks to them, however. First, they are expensive to set up, and they have some odd market standards. They have all of the normal closing costs of a loan. Mortgage insurance is required, not only when you take out the loan, but on the balance each year. Plus a nice fee, hundreds or even thousands of dollars, goes to the person who was nice enough to set it up for you.
Second, it’s hard to keep track of how much is owed. Unlike a regular mortgage or your credit card, where your monthly interest is included in your monthly payment, all you see is the check you receive. It’s all too easy to find that this “monthly income” has eaten away a huge amount of your equity.
Third, other options might be better suited and cost less. Regular home equity lines of credit often have fewer fees involved and have better rates. Younger relatives might be willing to simply buy an interest in your house as an investment with the hopes that it will keep appreciating. Then the retirees can remain with no interest accruing at all.
One very nice thing about reverse mortgages is that the withdrawals are tax-free up to the price you paid on it. If you have a choice between selling stock that earns 10% and is taxable, and borrowing against equity at 5% when it’s not taxable, a reverse mortgage may be a very real choice. You also don’t have to cash in all of the equity at once. You can borrow pieces at a time, and even pay them off if things suddenly get better.
Perhaps the best time to look at a reverse mortgage is with a person that is becoming increasingly disabled. Borrowing against equity to alter the residence or bring in people to help a person stay in the home as long as possible can greatly enhance the remainder of his or her life.