When one door closes, another one opens but we often look so long and regretfully at the closed door that we fail to see the one that has opened for us.
–Alexander Graham Bell
One of the biggest challenges that you must face when you retire is replacing the steady income you have become accustomed to throughout your working life: namely, your paycheck. Many of us will have some sort of pension income, or can generate income from our 401(k) or other investments; and, eventually, we can count on at least some income from Social Security. But these various sources of income may not be sufficient to meet our day-to-day needs.
If you find that you are cash-poor but house-rich, you might take advantage of a relatively new program that has been approved through the U.S. Department of Housing and Urban Development (HUD), called a reverse mortgage. This is a form of loan that is available to seniors, which releases the equity in the borrower’s home in a lump sum or a series of payments. The lender will pay you, up front, for the equity you have accrued in your home. You will not need to repay the loan until you move out of your home, or sell your home, or pass away.
Qualifications for a reverse mortgage
To be approved for such a loan, you must be 62 years of age or older; you must live in the home on which the reverse mortgage is taken out as your primary residence; any conventional mortgages must be paid off in full, or have low enough balances so that the proceeds from the reverse mortgage can pay them off; and you must be financially able to maintain the home — you must still pay taxes, insurance, utilities, and other ongoing expenses.
Benefits of a Reverse Mortgage
You will maintain the title to your home for as long as you live there, and you can use the proceeds from a reverse mortgage in any way that you wish. If you are still living in the home and the reverse mortgage loan is still outstanding when you pass away, your heirs will inherit your home, but your estate will still be responsible for paying back the loan. If your estate and your heirs do not have the cash to pay the loan, the house in most cases will be sold, and the proceeds from the sale will be used to pay back the loan. If there are excess proceeds from the sale after the loan is paid off, your heirs will keep the profit; if the sale price is less than the loan amount, your heirs will not have to pay the extra amount due from their own resources; the lender, or the lender’s insurance coverage, will have to cover the difference.
Disadvantages of a reverse mortgage
Although reverse mortgages are a good way to generate retirement income if your assets are primarily tied up in your house rather than in cash or investment accounts, there are disadvantages as well. The most frequent criticism of reverse mortgages is that they are costly. Start-up fees can cost $8,000 or more, and the interest that accrues on a monthly basis is treated as a loan advance. These sums will eventually need to be paid back, and they will come out of your home’s equity. It is quite possible that your heirs will end up with little or no equity in your house once you pass away; if you intend to pass your home on to them as part of your estate, make sure that they understand this.
Also, reverse mortgage agreements are complex and sometimes difficult to understand. You may want to seek advice from a financial advisor or other counselor before entering into such an agreement. Don’t let a salesman talk you into an agreement that you don’t fully understand.
A reverse mortgage is not a “magic bullet,” but one possible source of income during your retirement; be sure to weigh a reverse mortgage against other options you may have before committing yourself.