Reverse mortgages may once have been considered a financial tool primarily for elder care planning. However, these products have slowly been finding a niche for themselves in the broader consumer finance market. If you or a loved one is considering one of these loans, it’s important to know what you’re getting into.
How they work
Under a reverse mortgage, homeowners age 62 or older borrow money from a bank against their accumulated home equity — generally as a line of credit, monthly payment or lump sum. Meanwhile, the homeowner must continue to pay property taxes, insurance and other home-related expenses. The loan comes due when the house is sold or the borrower dies.
If the borrower sells the home, the interest on the reverse mortgage may be deductible for federal tax purposes. If the bank sells the home to pay off the balance, it will return any dollars beyond the outstanding amount to the borrower or his or her estate.
A few years ago, reverse mortgages appeared to be on the brink of a big popularity breakthrough. Of qualifying homeowners, however, a mere estimated 2% to 3% have reverse mortgages, according to the Consumer Financial Protection Bureau’s (CFPB’s) 2012 Reverse Mortgages: Report to Congress. The report also found that approximately 70,000 new reverse mortgages originate annually — a comparatively small number.
Another interesting trend regarding reverse mortgages: Borrowers are relatively young. Nearly half of them are under the age of 70, according to the CFPB’s report.
Purposes and risks
Reverse mortgages were designed as a means of supplementing retirement income by getting cash out of a home without selling it. But they initially gained a reputation as an effective way to allow homeowners to stay in their homes while dealing with expensive medical problems.
Yet reverse-mortgage borrowers are viewing the loans much more broadly these days — and often taking their money upfront. Fixed-rate, lump-sum loans now represent more than 70% of the reverse mortgage market, according to the CFPB report. Many reverse mortgagees are using this ready cash for more enjoyable purposes than medical expenses, such as travel, buying recreational vehicles or funding vacation home purchases.
Reverse mortgages do have their risks. With so much life presumably ahead of them, those aforementioned younger reverse mortgagees may exhaust their financial resources during their lifetimes.
Suppose that the borrower has little or no equity at a time that they need to move out because of a medical (or other) reason. The lender sells the home, using most — or even all — of the proceeds to pay off the loan, leaving the homeowner with little or nothing from the sale. Even in the absence of medical need, borrowers run the risk of burning through a lump-sum loan and falling behind on their taxes or insurance, putting them at risk for foreclosure.
These arrangements are also complex and may catch some borrowers off guard if they aren’t fully informed. There’s even a danger of fraud if a disreputable lender is involved.
Just one option
Under the right circumstances, reverse mortgages can be helpful. But there are other ways homeowners can get cash out of their homes without selling them, such as home equity loans or home equity lines of credit. Again, before signing off on a reverse mortgage, review its terms with a financial advisor and be sure the arrangement is a feasible solution to the problem or objective at hand.