The good news is that housing prices are on the rise, with the Detroit area showing some of the highest recovery rates (albeit from really low levels) in the nation. The rise in home values has increased interest in reverse mortgages, which can be a boon to some and a curse to others.
What Is a Reverse Mortgage?
As the name suggests, a reverse mortgage loan has the lender making mortgage payments to you based on the equity in your home. You do not have to pay back the loan and accumulated interest until you stop living there. “Great idea,” you say, “where do I sign?” Well, there are some caveats: you must be the homeowner, at least 62 years old, and have sufficient equity in your home to justify the loan.
Pros: The product was designed for seniors whose main asset is their home. The lending decision is based solely on the value of the home net of what is owed, so you do not need to meet any credit or income requirements. If done right, a reverse mortgage allows seniors to have a steady stream of income without selling their home. When they are no longer able to live independently, the sale of the home will enable them to pay off the loan and accumulated interest, and leave enough to provide for their end-of-life care or funeral expenses.
Cons: As the saying goes “the road to hell is paved with good intentions”…so one must tread carefully when considering a reverse mortgage. For starters, it is very expensive. In addition to regular closing costs, in some cases, borrowers must pay for a reverse mortgage counselor, mortgage insurance, and higher origination costs at closing. The interest rate charged is generally higher than traditional loans and you will pay for ongoing insurance premiums and servicing costs that accumulate on the balance owed. Over time, the accumulating loan balance significantly erodes the value you retain in your home. Homeowners are still responsible for paying taxes and insurance on their homes, as well as maintenance and utilities. If you obtain a reverse mortgage too early (getting one in your seventies or later is preferable), the amount owed may ultimately exceed the value of your home, and you may end up losing it to the lender, without the “nest egg” you thought you had for those golden years.
Reverse mortgages are often not understood well, making the market prone to scams or aggressive lending practices. Since the financial crisis, established lenders have exited the market and smaller mortgage brokers and lenders have entered to fill the void. Unwary seniors are attracted to the “easy money,” which can be obtained in a lump sum and spent in a heartbeat. Once the proceeds have been spent, they run the risk of losing their homes due to clauses that make the loans payable if they fall behind on their taxes, insurance, or maintenance.
Unlike a traditional mortgage, you don’t make installment payments on a reverse mortgage. If you die, or move away for more than a year, the reverse mortgage loan is due in full. So you or your heirs will have to pay off the entire loan balance to keep your home.
Bottom Line: A reverse mortgage should be the last resort, something you consider only after you have explored other, less-costly alternatives. The state of Michigan (http://www.state.mi.us/MSHDA/serve/serve_seniors.html) has a number of lending options and services for seniors, as does the Detroit Area Agency on Aging (http://www.daaa1a.org/DAAA/). If you have done your homework and still think a reverse mortgage is the right decision for you, have someone else you trust read the contract carefully before you sign on the dotted line. To quote Aesop: “Affairs are easier of entrance than of exit; and it is but common prudence to see our way out before we venture in.”
Ina Fernandez CPA has 25 years of investment experience, and is currently Managing Director at Liberty Capital Management, Inc.