For homeowners from the GI and Baby Boomer generations, the idea of a reverse mortgage may sound like a viable option to help reduce the stress of declining income and increased living costs. Perhaps you've seen the commercials for reverse mortgages that make them sound risk-free, easy and give you peace of mind like nothing else.
Let's unpackage this idea of a reverse mortgage.
The reverse mortgage was birthed out of the idea to give retirees use the equity in their homes to supplement their limited income. Instead of making a monthly payment to a lender, the reverse mortgage allows you to convert part of the equity in your home into a monthly payment you receive from the mortgage company.
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You're likely thinking one of two things: That's awesome, sign me up! Or, what's the catch, nothing is that simple?
The idea of getting paid to live in your home does have an appeal, doesn't it? Especially after you have worked hard so many years to maintain your home knowing one day you could cash it in as your nest egg. You've built your equity through diligent payments, maintenance, and repairs (and maybe some help from the housing market) so why not utilize a reverse mortgage to get that equity out of your home? There are pitfalls of reverse mortgages and there are wrong reasons to pursue this route.
The Wrong Reason To Seek A Reverse Mortgage
If you are struggling to pay bills because your spending is out of control, you don't have a budget and you see it as a quick-fix to your money problems, you do not need a reverse mortgage, you need to manage your money better.
A reverse mortgage is a loan against your equity. It will need to be repaid at some point in the future.
Like a credit card, a line of credit, or loan from a friend – more spending ability is like putting a band-aid on a broken arm. The real cause of your financial pain is still there and will only get worse if you don't address it properly. Reverse mortgages can give you the ability to stay in your home while drawing out the equity you have built up but what good is more money if you don't know how to use it? If you are in your 60's and use up the majority of your equity without rectifying daily money management problems you will find yourself in the same position in your 70's or 80's only with less equity and possibly a hard time moving.
Pitfalls of a Reverse Mortgage
There are several cautionary details you should know before considering a reverse mortgage:
- Fees! Just like a traditional mortgage, there are fees and plenty of them. Appraisal fees, origination fees, closing costs and more.
- You will pay interest and it's generally higher. This isn't free money you're getting. It is, in essence, a loan against your equity and you will pay interest.
- You'll need counseling first. Yes, the rules require that you have counseling through a U.S. Department of Housing and Urban Development (HUD) sanctioned counselor.
- When you sell you may have little left. Because you are eating away at your home's equity, when you do sell (by choice or circumstance) you could end up with very little money left. Remember, you are using the equity before you sell the home in the form of a loan and it must be paid back. It isn't free and clear money.
- Scams. It shouldn't surprise you that there are many scams waiting to prey on potential reverse mortgage borrowers. You and your loved ones must be diligent in your research when seeking a lender.
You can read more about these details here.
The other risks are more personal in nature. If you have a desire to leave your home or an inheritance from the home's sale to your children a reverse mortgage can severely limit this. That's because the reverse mortgage is a loan that will need to be paid once you die or sell the house.
And if you are unable to keep up with taxes and insurance you risk foreclosure.
When I hear clients talk about reverse mortgages they often see it as a way to avoid debt but in reality, you are still going to pay for it, with interest so it is a form of debt. If you're considering a reverse mortgage because it's a means to less debt you need to reconsider. The strings attached to a reverse mortgage aren't worth it. You might consider these options:
- A Home Equity Loan. Borrow a fixed amount against the equity in your home and pay it back over time.
- A Home Equity Line of Credit (HeLOC) – This allows you to borrow on an as-needed basis against the equity of your home.
- Refinance your mortgage. If you're able, this can allow yo to take advantage of a possible interest rate reduction.
- Downsize now. If you cannot aford it, stop owning it.
I'm a big fan of number four. Sell your house now. Sell it to your children (with help from an attorney), or sell it on the market. Use the proceeds to pay off your debts, beef up your savings and live somewhere that is within your means. I know there are sentimental attachments to your home but don't let emotions rule your decisions when it comes to your financial health. Walls and windows don't make your family and they don't keep memories. Downsizing personal things and property size can have a huge positive impact on your finances, plus it can give you the freedom to enjoy your golden years with less worry on home maintenance.
The Number One Thing You Need To Do
If you do not live within your means, keep a healthy savings account, pay off debts and avoid new ones, none of the above solutions will give you long-term relief from your financial stressors. It doesn't matter if you choose a reverse mortgage or an alternative, if you do not address the root causes of your money issues, you'll see no lasting changes in the climate of your finances.
If you're considering a reverse mortgage be sure that your motivation is right and your not looking for a quick fix to a deeper issue. Before taking on any more debts like this consult with your budget coach and your family. No budget coach? Mvelopes budget coaching is an amazing resource.