Reverse mortgages can aid in improving some retirees' financial situation, but a number of considerations mean that they should be approached with caution.
That's according to a blog post from the Pension Research Council that appeared on Forbes and explored the pros and cons of taking advantage of "an asset that almost 80 percent of retirees have," the post said, "the family home."
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Using a reverse mortgage, also known as a home equity conversion mortgage, to unlock the cash value of the equity in one's home can provide homeowners over age 62 to access some of their home equity as periodic payments or a line of credit, the PRC wrote.
Federally guaranteed and regulated HECMs create a mortgage that is repaid with interest when the borrower dies, or moves out of the home.
HECMs are "nonrecourse" loans; that means the borrower will never owe more than the loan balance or the value of the property, whichever is less.
And while reverse mortgages get plenty of airplay in TV advertising, at present fewer than 2 percent of retired households use reverse mortgages in the U.S.
There are several types of reverse mortgages, but the tenure option, in which payments to the retiree are made for as long as the borrower lives in the home, "is the most effective way to solve the problem of a retirement income gap," the PRC wrote.
In addition, "it also permits the possibility of leaving some bequest, which motivates nearly two-thirds of retired households."
However, there are caveats, some of them substantial.
One is the amount of fees, many of which are fixed, on such products.
Mortgage origination and other fees, insurance premiums, servicing charges, and a lender's margin, which the PRC said is usually 2 percent or more, when added to the base interest rate, can make such products not worthwhile for those at the low end of the asset spectrum—particularly if their homes are valued at less than $100,000.
All those fees can end up costing as much as $13,800 in fees on a $200,000 house. People with few or no financial assets would find themselves with no liquidity if they took such a mortgage.
Those on the higher end of the asset spectrum could be better off with an immediate life annuity with a cash refund feature, since it would provide a higher lifetime income cash flow.
Those in the middle, "with some modest assets but a more significant home value …. with financial assets of $3,000 and a house valued at $60,000 on the lower end, and financial assets of $290,000 and house of $250,000 on the upper end," could benefit from HECMs.
PRC's data analysis "suggests that about 14 percent of the retired population would find a reverse mortgage suitable, and they would receive about a 19 percent income boost from a reverse mortgage."
That said, PRC warned that "if people are thinking of using their family homes as a source of funding to cover future long-term care costs, then a reverse mortgage might not be so attractive. This is particularly true if people have no long-term care insurance or if Medicaid coverage for long-term care expenses is not an option."
And there's another big caveat: the potential for predatory lenders to foreclose.
Counting on the potential for befuddled seniors to misunderstand paperwork or simply ignore filings that aren't true, a new strategy by lenders' and plaintiffs' lawyers is to sue to foreclose on government-guaranteed home loans under various defaults, then fast-track these suits by filing motions for orders to show cause.
The defaults are not valid—some seniors are even served at their homes in suits alleging that they no longer live in those homes—but that hasn't stopped the trend from growing in retiree haven Florida, where authorities expect that it's likely to spread to other parts of the country.
While there are advantages to be had from reverse mortgages, particularly if costs can be reduced so that they're beneficial for a wider range of seniors, the risks involved must also be carefully evaluated before going down that path—or else there may be no going back.
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