Reverse Mortgages Explained: Is Selling A Better Option?

Selling your home could be more advantageous than a reverse mortgage

For many homeowners, life situations may alter the best financial course of action for them when it comes to keeping or selling their property. Refinancing one’s home may be a necessary consideration, and a reverse mortgage may seem like a viable option.

What is a reverse mortgage?

A reverse mortgage is a type of mortgage through which a homeowner can borrow money against the value of their home. They receive funds in the form of a fixed monthly payment or a line of credit. There is no repayment of the mortgage that is required until the borrower dies, moves away or puts the home up for sale.

It is set up so that the amount of the reverse mortgage will not exceed the value of the home over the course of the loan.

They’ve been around for decades but recently people have become more and more aware of them as a potential debt instrument for homeowners. Reverse mortgages are sometimes cast in a negative light. The financial community as well as the media has been known to be skeptical of them.

Despite this, though, reverse mortgages have become increasingly popular amongst people who are “house rich and cash poor.” This is particularly true of many senior citizens who need additional income to pay for health or long-term care

How do reverse mortgages work?

Reverse mortgages function in the opposite way of a traditional mortgage. With a traditional mortgage, a homeowner borrows money from a lender when they purchase a home. They then make monthly payments to the lender to pay off the balance, while simultaneously building equity in their home. As time goes by, the homeowner lowers their debt by contributing to their mortgage, and in doing this, they increase their home equity increases. Once the mortgage is fully paid, the homeowner officially owns the home outright, never owing anything further to the lender.

A reverse mortgage, as the name suggests, works in the opposite way. Instead of making monthly payments to a lender, a homeowner receives monthly payments from them based on a percentage of the value of the home. This can be paid as a single lump sum. It can also be paid as a regular monthly cash advance that is paid for either as long as the homeowner lives in the home, or based on a certain number of years. Alternatively, it can be paid as a line of credit, or a combination of these options.

Regardless of how the reverse mortgage is set up, the homeowner will keep the title to their home. This serves as collateral for the loan. The homeowner is charged interests solely on the proceeds they receive. Both fixed and variable interest rates are available. Any interest will compound over the span of the reverse mortgage until repayment happens.

The long run

Over time, debt will increase while home equity will decrease for the homeowner. When the homeowner moves, sells the home or passes away, the lender will sell the home to regain the money that they would have paid out.

Once lender fees have been paid, any remaining equity in the home will be received by the homeowner, or in the case of death, by their heirs. In some cases, an heir will have the choiceto repay the mortgage without actually selling the home. According to the Federal Trade Commission, if the homeowner receives more payments than the home is worth, they will never owe more than the value of the home.

Should the homeowner fail to meet the obligations of the mortgages, for example, if they do not pay their taxes or insurance, or if the property falls into a state of disrepair, the reverse mortgage could become due. The homeowner is responsible for paying property taxes, homeowners insurance and for the overall maintenance of their home. But if the value dips lower than the amount the homeowner has borrowed for other reasons, such as a decline in the real estate market, the homeowner can’t be foreclosed upon.

What are the different types of reverse mortgages?

There are multiple kinds of reverse mortgages available. These include single-purpose reverse mortgages, federally-insured reverse mortgages and proprietary reverse mortgages.

Single-purpose reverse mortgages

Single-purpose reverse mortgages are usually aimed toward low to moderate income homeowners. The lender of this type of reverse mortgage decides how it can be used. It may be used to pay property taxes or to go toward repairs to the home.

Federally-insured reverse mortgages

Federally-insured reverse mortgages are also known as Home Equity Conversion mortgages. They are issued by private banks. Home Equity Conversion mortgages are insured by the Federal Housing Administration. They are the only reverse mortgage product that is guaranteed by the federal government.There are no restrictions in terms of income or medical conditions. There are also no regulations as to how the money from these types of mortgages can be spent. The main downside, though, is that for this type of reverse mortgage, the maximum loan amount is limited. At the moment, it Is limited to the lesser of the appraised value of the home or the HECM FHA mortgage limit of $625,500.

Proprietary reverse mortgages

These types of reverse mortgage can also be accessed from various lending organizations. They offer amounts that are higher than HECM loans, but the difference is they are not federally insured. They can also be significantly more expensive. Homeowners with homes of higher value will find these types of mortgages the most advantageous.

Pros and cons of reverse mortgage

As with most financial decisions, there are many pros and cons to consider. Here are few of the positive aspects as well as drawbacks to getting a reverse mortgage.

Pros

  • For a homeowner planning to stay in their home, a reverse mortgage can be a good, reliable source of cash flow.
  • It’s easier to qualify for a reverse mortgage than a traditional mortgage. This is because your credit score does not play a role in your application. In addition, you only need enough income or assets to continue to pay for things like homeowners insurance, property taxes and costs associated with maintaining your home.
  • For seniors, there are no taxes on the money that they get from a reverse mortgage. Since it’s not considered income, it’s not taxable.

Cons

  • The interest generated by the loan is not tax-deductible over its term. The only way that it can be deducted is when the loan is fully paid off.
  • Reverse mortgage loans can actually be more expensive than they appear at first. In addition to interest, reverse mortgages have a lot of fees and extra costs, such as mortgage insurance. These extra costs can add up quickly.  Sometimes it comes to the point where they are actually more expensive than regular mortgage fees. (To avoid this, it may be suggested to take out a reverse mortgage as a line of credit as opposed to a lump sum payment. By doing this, the homeowner only pays the interest and annual insurance premiums in the amount that is actually being withdrawn).
  • HECM sets loans on how much you can borrow from a reverse mortgage, particularly in the first year
  • Reverse mortgages use up equity in your home
  • Homeowners and their heirs will be left with fewer assets
  • Homeowners will not be able to give or sell their home to their children during their lifetime without repaying the mortgage first.

Selling your home vs. getting a reverse mortgage

For homeowners that are considering refinancing their home for additional income, there’s another option. They may consider selling their home altogether. For a homeowner who is willing and able to move, this could be advantageous. Selling gives the homeowner the ability to leverage the equity that they have built from their property.

Selling could be a better option anyway if the home is too big for the homeowner’s current needs. Many people decide to downsize after children grow up and move into homes of their own. Furthermore, if the current home is costly to maintain, or has high property taxes, moving into a smaller home may be a better option. Proceeds from the sale of the original home can be used to finance a smaller and more affordable home.

Another option for homeowners considering a reverse mortgage is to sell their home to their kids. A sales-leaseback agreement allows homeowners to sell their house. They then rent it back to using money generated from the sale.

The bottom line

Whichever route a homeowner decides to take, it is important to carefully evaluate the pros and cons as well as the financial implications of their decision. While reverse mortgages may be beneficial for some, selling may be a better and more lucrative option in the long run if it is affordable.

If after assessing your financial situation, selling seems like the best option for you, SoldNest can help. We provide expert real estate insights and digital marketing expertise for your property at just a 1.5% fee. We can maximize your final sales price while saving you money.

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