NEW YORK (MainStreet)As its name suggests, a reverse mortgage is kind of the opposite of a mortgage. Instead of borrowing money from a bank to buy a house, a reverse mortgage is when the bank pays you to sell them your house. Reverse mortgages can be given in the form of one lump sum payment, or as monthly payments that you receive over time.
The monthly payments are particularly attractive to retirees, because they only end when the retiree dies. If you live long enough, the bank could wind up paying you significantly more than the home itself is worth. For this reason, banks will calculate how much they will lend you not only based on the value of the home, but also your age. There are even FHA approved reverse mortgage programs. These are called HECM loans (that's "Home Equity Conversion Mortgage"). With this program, banks will pay around 50% of the home's fair-market value. Reverse mortgages are available on houses and condos in all 50 states.
The biggest benefit of a reverse mortgage is that it is a reliable income stream that retirees can rely on. "It's a great last-resort cash resource for retirees," says Carl Friedrich, chief investment officer at Piermont Wealth Management. Friedrich notes that retirees who do not want to leave their home to their children for whatever reason can take advantage of reverse mortgages to access the equity in their homes without facing the risk of having to leave their home.
That is key.
"If you have decided this is the last home you will ever live in, then a reverse mortgage can make sense," said Friedrich. "But you have to be sure--if you decide to move later, things can get complicated."
Although it is a way to draw income out of a home, Friedrich says he rarely recommends reverse mortgages because of a number of problems with the products. Number one is fees. "Fees are lower than at their peak, but they're still significant," Friedrich says. "Even HECM saver loans, which have lower upfront costs, will cost around $5,000 to $10,000 to get a reverse mortgage with a rate around 4%."
Costs have also been a concern for FINRA, which recently issued an alert about the dangers behind reverse mortgages. "We tried to warn people about the reverse mortgages that are out there. We encourage consumers to consider cost," says Gerri Walsh, senior vice president of FINRA Investor Education. "They can be very expensive options and if you're using them for vacations and things that are wants instead of needs, it can be a much more expensive than other financial products on the market."
Walsh notes that many seniors do not realize that they are essentially taking a loan on their home, because of the way these products are marketed. "One of the things that scares me is that if someone uses their home for leverage for any purchase, it can be very costly if that investment or that purchase goes south," says Walsh. "If you use a reverse mortgage to purchase an investment and it loses its value, you're left with nothing unless you pay off the reverse mortgage in full."
Friedrich notes that reverse mortgages are becoming riskier, because more of these products are being based on a variable interest rate.
"With HECM saver loans, which are administered by the FHA, upfront costs are a lot lower, but most of these are offered with a variable rate," says Friedrich. "That's because rates are very low, and if rates on a HECM loan go up, you could end up owing more on the home than it's worth very quickly with one of these reverse mortgages."
--Written by Michael Foster for MainStreet