On Wall Street, traders often speak of being “liquid,” i.e. having enough cash on hand to weather any financial storms.
Liquidity is important too, for America’s senior citizens. Studies show that millions of Americans don’t have enough cash to meet everyday needs, especially when it comes to housing and living expenses associated with long-term care.
That’s not a theory—it’s a fact. According to a 2010 study from Hewitt & Associates, about 80% of Americans head into retirement without enough savings to live on.
But Americans either nearing or already in retirement age have another option if their cash flow runs low: reverse mortgages.
What Are Reverse Mortgages?
Aptly named, reverse mortgages enable senior homeowners, particularly those with significant equity in their homes, to get some cash out of their homes with no tax penalties.
Reverse mortgages are limited to homeowners with low mortgage balances who are 62 years or older, an appropriate demographic for those seeking more cash to pay for their senior housing and healthcare needs.
By and large, seniors use reverse mortgages to augment their existing funding sources, such as Social Security, and to meet unexpected medical expenses, pay real estate taxes, and for travel and vacations.
How Do Reverse Mortgages Work?
Public and private financial organizations will buy the equity in your home, e.g. your mortgage, and pay you for the privilege. The amount of money you can earn from a reverse mortgage depends on your age, current interest rate levels (which are at historic lows these days), and the appraise value of your home. (For a good handle on what you might get from a reverse mortgage, try this handy calculator).
You can receive payments in a variety of funding sources:
- As a lump sum payment – where you take the entire reverse mortgage payment.
- Via regular payments – reverse mortgage firms can also pay you on an annuity basis, such as monthly payments.
- Line of credit – like a home equity account, you can also access a reverse mortgage fund via a line of credit, tapping into your account as you need the money.
In return, the reverse mortgage company will own the mortgage and your home after you pass away. In other words, you never have to repay the money you earn through a reverse mortgage.
Other key advantages from a home mortgage include:
- No monthly payments on your home.
- The title of the home remains in the possession of the homeowner and not the reverse mortgage lender.
- The home’s remaining equity still belongs to the homeowner.
- Since reverse mortgages are essentially “non-recourse” loans, the senior homeowner owes no more than the home’s actual value. That’s the case even when the loan amount is more than the estimated value of the home.
Risks of Reverse Mortgages
Like any financial instrument, reverse mortgages don’t come without risk. For example, while you can draw money out of your home equity through a reverse mortgage, you’re reducing your own equity in your home in the process. And after you’re gone, the house likely won’t go to your kids or other benefactors. It will likely fall into the hands of the reverse mortgage firm.
Other potential risks include:
- Ancillary fees and costs – Reverse mortgages come with a cornucopia of costs and charges, including the application, monthly payment, management fees, closing costs (including escrow and title fees) and mortgage insurance fees.
- ARM penalties - Reverse mortgage loans are often tied to that recessionary scourge, the Adjustable Rate Mortgage (ARM). With ARMs involved, your loan amount may escalate as your interest rate adjusts over time.
- Scams and fraud alerts – The United States (U.S.) Government has been increasingly active about warning consumers about the risks of reverse mortgages. The U.S. Department of Housing and Urban Development (HUD) and the Federal Reserve have both recently issued warnings to consumers over the hidden risks associated with reverse mortgages.
Says the Federal Reserve in a report issued August 16, 2010:
"Reverse mortgages present substantial risks both to institutions and to consumers, and, as with any type of loan that is secured by a consumer's home, it is crucial that consumers understand the terms of the product and the nature of their obligations," the agency said in a statement.
"Lenders must institute controls to protect consumers and to minimize the compliance and reputation risks for the institutions themselves," the Fed added.
Your best bet in searching for the right reverse mortgage might be worth the federal government. Start with the HUD website. Also check out a report from HUD on key things to know about reverse mortgages.
They’re not for everybody, but if you have some decent equity in your home and are over 62-years of age, a reverse mortgage might work for you—and for your senior living needs.
Written by senior finance expert Brian O’Connell.