You Decide: Should you use a reverse mortgage?
Robert Wagner, Henry Winkler, and Fred Thompson are each actors. Wagner’s career has spanned half a century in both films and TV. Winkler is best known as the Fonz on TV’s Happy Days and Thompson has sandwiched an acting career around a stint in the U.S. Senate.
Besides acting, the trio has something else in common. They are spokespersons for different companies offering a financial product called a reverse mortgage. But what exactly is a reverse mortgage, and is it something you should consider?
To start, let me first talk about a traditional mortgage. A mortgage is simply a large loan used to purchase a home. Such a loan can easily total several hundred thousand dollars, and the loan is secured by the value of the home, meaning that if the buyer can’t make all the loan payments, the firm making the mortgage takes possession of the home.
The mortgage is usually repaid over a long period (30 years is common) by the homebuyer making monthly payments. Each payment has a part that reduces the amount of the loan and a part that pays interest on the loan. If the homebuyer sells the home before the mortgage is completely repaid, proceeds from the home’s sale will be used to pay off the remainder of the loan. If the home’s value isn’t sufficient to repay the mortgage, then such the home is said to be “underwater,” and the owner obviously faces a financial problem.
If a homeowner is 62 or older and owns a home free and clear of a traditional mortgage, the owner can consider a reverse mortgage. The name is based on the fact that the circumstances for a reverse mortgage are the opposite of the circumstances for a traditional mortgage. In a reverse mortgage, the person owns the home with no outstanding loan; in a traditional mortgage, the person is buying the home and uses a loan (debt) to do so.
For a reverse mortgage, the person receives money; in a traditional mortgage, the person pays money. And although this certainly isn’t always the case, people using a reverse mortgage are often near the end of their lives, while users of a traditional mortgage are much younger.
A reverse mortgage is a way for the homeowner to draw money from the home’s value while still living in the home. In this way, it is similar to a home equity loan or a second mortgage. But compared to these two financial products, there are two distinguishing features of a reverse mortgage. First, repayment of the money received by the homeowner will usually come from the future sale of the home after the owner leaves.
Second, the payments received by the homeowner usually come monthly and last for a long time -- sometimes until the owner dies. In the case of lifetime monthly income, the probabilities of the owner dying in different years (the same factors used in life insurance calculations) are used to determine the monthly amounts.
Why would a 62-and-plus-year-old homeowner consider a reverse mortgage? If such a homeowner has a need for additional monthly income and has no other good options for obtaining that income, then a reverse mortgage might be the answer. The additional monthly income could be used to pay for normal household expenses, maybe to pay premiums for a long-term health care policy or used just for fun activities, like trips.
When considering a reverse mortgage, it should be remembered that the homeowner will still be liable for maintenance and repair expenses on the home as well as property taxes. And as with a traditional mortgage, there will be upfront fees and other expenses the homeowner must pay when the reverse mortgage is taken. The financial firm will also charge an interest rate and subtract interest costs from the monthly income paid to the homeowner. Interest is charged because the financial firm is paying the homeowner money now but is not repaid until later.
Homeowners considering reverse mortgages should shop competing financial companies and compare their terms for the fees, expenses and the interest rate.
Here is, perhaps, the blockbuster realization for considering a reverse mortgage. Use of a reverse mortgage means a significant part -- sometimes maybe all -- of the home’s value won’t be available in the homeowner’s estate. Statistics show a home is the largest financial component of many households’ estates. Many homeowners who are parents understandably want to pass their home’s value on to their children. A reverse mortgage reduces the ability to do this. Some surveys show that children of homeowners are overwhelmingly opposed to reverse mortgages!
So where does this leave you in deciding if a reverse mortgage is for you? If you’re elderly (like me), own your home with no loan, would like to have some additional monthly income and understand your children will be inheriting less, then a reverse mortgage may be a wise move. But do your homework first and compare fees, interest rates and other terms.
I like Bob (Wagner), Henry (Winkler) and Fred (Thompson) as actors, but let’s face it, they aren’t financial advisers. So when it comes to reverse mortgages, you decide how the pluses and minuses add up!
Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University’s College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy.