A reverse mortgage is essentially a loan that a client can take out against her home equity. The option—also known as a home equity conversion mortgage (HECM)—is available through the U.S. Department of Housing and Urban Development to homeowners who are at least 62 years old. The client must either own the home outright or must have a mortgage balance that is low enough so that it can be paid off with the reverse mortgage funds.
While interest is charged on the loan, no repayments are due until the client dies or moves out of the home. If the house is sold, the proceeds must be used to pay off the reverse mortgage.
The value of the loan depends upon the overall value of the home, though a total cap of $625,000 applies. Generally, the reverse mortgage may be available as a line or credit, through monthly payments or as a lump sum, though new restrictions apply in order to limit the amount that can be accessed within the first year of closing on the reverse mortgage.
Further, borrowers must now comply with new financial assessment rules that look at the borrower's credit history, income streams, bank statements, tax returns and other documentation in order to ensure that the borrower will have sufficient funds to maintain the home after the reverse mortgage is completed.
The Upside Potential
A reverse mortgage can be a useful solution for an older client who is planning to remain in the home until death. The reverse mortgage will eliminate any existing mortgage payments and, with proper planning, can provide necessary income to allow the client to remain in the home indefinitely.
Further, a reverse mortgage can allow a client who intends to remain in the home indefinitely to avoid drawing on retirement assets, or to defer Social Security benefits in order to receive a higher future benefit.
Clients with substantial investments in the equity markets may also view a reverse mortgage as an attractive solution in a down market, when investments can be left to regain value by tapping a reverse mortgage line of credit to make up for the shortfall.
In this situation, interest on the reverse mortgage will only accrue to the extent that the line of credit is drawn upon in order to equalize the client's income in anticipation of an eventual market rebound.
Potential Pitfalls
One of the most widespread problems associated with the use of a reverse mortgage is that homeowners take the risk that they will be unable to continue to pay expenses associated with maintaining the home. A client who takes out a reverse mortgage remains liable for paying expenses such as taxes, homeowner's fees and insurance associated with the home in order to avoid foreclosure.
New rules allow for funds to be set aside in order to satisfy these costs, but if funds are not set aside and the borrower incurs unanticipated expenses that preclude payment of taxes, insurance or other expenses, the lender is entitled to foreclose.
