You may be all too familiar with commercials featuring folksy celebrities explaining how reverse mortgages sound "too good to be true," but there isn't a catch this time. You can have the best of both worlds: You can stay in your home and get cash for the equity you have built up. What's more, you never have to pay back the loan.
A reverse mortgage is a home loan available only to those 62 years of age and older. Unlike typical loans, no monthly repayment of these loans is required. Senior citizens can tap into the equity they have built up in their homes. Payment of the loan is deferred until they die, transfer ownership of their home, fail to pay taxes or insurance, fail to keep the home in good repair or move out.
According to a report prepared by the Consumer Financial Protection Bureau for Congress in June of 2012, there are a number of issues with reverse mortgages. Few of these problems are referenced in the rosy picture painted by those who sell these products. However, for some seniors, it may be an appropriate option that will permit them to remain in their homes and access funds needed to pay their living expenses in retirement.
If you are considering a reverse mortgage, there are other options that will permit you to gain access to the equity in your home. These options may (or may not) be preferable to a reverse mortgage.
1. Refinance your home. Refinancing your home does not come without costs. According to Bankrate's 2012 closing costs survey, the national average for closing costs on a $200,000 loan was $3,754. Nevertheless, if you plan on staying in your home for a meaningful period of time, refinancing can be an appealing option. Assuming interest rates are favorable, your monthly payment will be less, which will free up some cash. In addition, your home will remain an asset for you and your heirs, which is not the case when you take out a reverse mortgage.
2. Take out a home equity loan or line of credit. A home equity loan will give you a lump-sum payment that you will have to pay back in fixed monthly installments over a stated period of time. Most home equity loans bear a fixed rate of interest. A home equity line of credit gives you the right to borrow money up to a stated limit. The interest on a home equity line of credit typically fluctuates with the prime rate.
Whether a home equity loan or a home equity line of credit is right for you depends on a number of factors, including whether or not you need a lump-sum payment immediately or are concerned about having cash available on an as-needed basis. Remember that with a home equity loan, you are paying interest on the entire amount of the loan, whether or not you are using the proceeds. With a home equity line of credit, you only pay interest on the amount you borrow.
Typically, a home equity loan or line of credit features low fees. Home equity loans and home equity lines of credit are easier and less expensive to obtain than a reverse mortgage. Both preserve your home as an asset for you and your heirs. However, be aware that failure to make repayments as required (including interest) may put your home at risk of foreclosure.
The Federal Reserve Board published a useful guide for those considering home equity loans or a line of credit.
3. Sell your home to a third party. Obviously, this option does not permit you to stay in your home, but it will give you access to the equity you have built up. If your home is too big for your current needs, or if you are facing significant repair costs or high taxes, consider selling and renting an apartment or purchasing a lower-cost home or condominium.
4. Sell your home to your children. First, there some caveats. Mixing business with family is fraught with peril. If you decide to sell your home to your children, you should execute the same carefully prepared agreements you would have in a sale to an unaffiliated third party. You and your children (or child) should each retain experienced real estate attorneys.
Steve McLinden, who writes Bankrate's Real Estate Adviser column, outlines a number of ways to execute a transfer of title to your children, saying that one of the easiest approaches is to finance the sale, permitting your child to make monthly payments directly to you instead of going through a third-party lender. Assuming it is financially feasible for everyone concerned, and consistent with the value of your home, you can structure the monthly payments based on your need for income.
The agreement should provide that the title transfers back to you in the event of a default. If none of these options is viable, consider obtaining a loan against your whole or universal life policy. You could also take a distribution from your 401(k) plan (which you can do without penalty if you are 591/2 or older) or borrow from your 401(k) plan, assuming loans are permitted by your company plan. Loans from 401(k) plans are subject to borrowing limits, repayment requirements and other restrictions.
Of course, you also have the option of delaying retirement, or going back to work full or part-time if you are already retired. All of these options should be fully explored when you are considering a reverse mortgage.
Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth advisor with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His latest book, "The Smartest Sales Book You'll Ever Read," has just been published.