Reverse mortgages are loans available to people over 62 who would like to borrow against the value of their homes.
They are often exorbitantly expensive — requiring additional premiums and fees.Instead of interest compounding on a lower number every month, like a regular mortgage, reverse mortgages compound on a higher number because of the additional premiums.
In the case of death, your estate will have to pay off the remaining balance — and if you move out of the house, you have a year to close the loan.
The following is an adaptation from “You Don’t Have to Drive an Uber in Retirement”:I’m generally not a fan of financial products pitched by former TV stars like Henry Winkler and Alan Thicke — and it’s not because I once had a screaming argument with Thicke (true story).When financial products need the Fonz or the dad from Growing Pains to convince you it’s a good idea — it probably isn’t.
What were they pitching on tv?
Reverse mortgages.When you buy a home and take out a mortgage, you borrow money, interest accrues every month, and you make monthly payments.A reverse mortgage is kind of the opposite of that. You already own the house, the bank gives you the money up front, interest accrues every month, and the loan isn’t paid back until you pass away or move out.If you die, you never pay back the loan. Your estate does.
And your estate won’t have to pay more than the value of the house.When you take out a reverse mortgage, you can take the money as a lump sum or as a line of credit anytime you want.
Sounds good, right?
The fact is reverse mortgages are exorbitantly expensive loans. Like a regular mortgage, you’ll pay various fees and closing costs that will total thousands of dollars. Additionally, you’ll pay a mortgage insurance premium.
With a regular mortgage, you can avoid paying for mortgage insurance if your down payment is 20% or more of the purchase price. Since you’re not making a down payment on a reverse mortgage, you pay the premium on mortgage insurance.
The premium equals 0.5% if you take out a loan equal to 60% or less of the appraised value of the home. The premium jumps to a whopping 2.5% if the loan totals more than 60% of the home’s value.If your home is appraised at $450,000 and you take out a $300,000 reverse mortgage, it will cost you an additional $7,500 on top of all of the other closing costs.
You’ll also get charged roughly $30 to $35 per month as a service fee. The total is charged based on your life expectancy. If you are expected to live another 10 years (120 months) you’ll be charged another $3,600 to $4,200. That figure will be deducted from the amount you receive.Most of the fees and expenses can be rolled into the loan, which means they compound over time.
And this is an important distinction between a regular mortgage and reverse mortgage: When you make payments on a regular mortgage each month, you are paying down interest and principal, reducing the amount you owe. Because you never pay down your reverse mortgage, the figure compounds month after month.
A regular mortgage compounds on a lower figure each month. A reverse mortgage compounds on a higher number.If you pass away, your estate pays back the loan with the proceeds from the sale of your house. If one of your heirs wants to live in the house (even if they already do), they will have to find the money to pay back the reverse mortgage; otherwise, they have to sell the home.
The other trigger for repayment is that you move out of the home. Once you do, you have a year to close the loan.If you move to a nursing home, you’ll probably need the equity in your home to pay those costs. In 2016, the average cost of a nursing home was $81,128 per year for a semi-private room.
If you owe a lender a substantial piece of the equity in your home, there won’t be much left for the nursing home. In that case, unless your kids step up to pay for it, you’re going to a Medicaid facility, which is something you probably want to avoid.
The high costs of reverse mortgages are not worth it for most people. You’re better off selling your home and moving to a cheaper place, keeping whatever equity you have in your pocket rather than owing it to a reverse mortgage lender.
This article is adapted from “You Don’t Have to Drive an Uber in Retirement” (Wiley) by Marc Lichtenfeld.Marc is Chief Income Strategist at the Oxford Club and Senior Editor of The Oxford Income Letter, where he runs the Instant Income Portfolio, Compound Income Portfolio and Retirement Catch-Up/High Yield Portfolio. You can follow him on Twitter @stocksnboxingRead the original article on Contributor. Copyright 2018.