Top 7 Questions to Ask Before Getting a Reverse Mortgage
By Tim Paul
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You’ve probably heard about reverse mortgages from ads that make them sound like the best thing since fresh air. In the right circumstances, they can be very effective tools for generating additional retirement income for senior homeowners age 62 and over. But reverse mortgages are also bewilderingly complex financial products. Here are 7 important questions to consider before taking out a reverse mortgage:
- Am I the Right Age for a Reverse Mortgage?
All reverse mortgage products require that the youngest homeowner (you or your spouse) be 62 years old at the time of closing. The age of the youngest homeowner is the key – either they’re 62 or they’re not.
But age is used not only to assess whether basic program qualifications are met; age has an even more significant role in determining how much can be borrowed. Simply put, the older you are, the more you can borrow.
Older is not always better, however. This is because up front costs associated with reverse mortgages are much higher than for conventional mortgages. It is not uncommon for fees and costs associated with obtaining a reverse mortgage to be 10-20% of the amount of the reverse mortgage. Fees can easily amount to more than $10,000. From the borrower’s standpoint, the only way to justify paying these high up front costs is to carry the loan for several years – at least seven. It’s easy to see that a 90-year old has a limited odds of doing this.
The “Goldilocks” age – not too young and not too old – best suited for reverse mortgage borrowers seems to be the mid-seventies.
- How long do I expect to stay in my home?
Studies and surveys show most older Americans would prefer to "age in place" in their own homes. As previously noted, seven years should be considered the minimum time period for a reverse mortgage to be a cost-effective option. If this doesn’t seem likely, you should consider other options.
- How long do I expect to live?
You may not want to think about how many years you have left or fix a projected date of your demise, but be assured reverse mortgage lenders have a pretty specific idea of when they think you’ll be gone. The issue is fairly simple: live longer than “they” assume you will and you come out a winner.
You actually have better information about your life expectancy than you might think. Only you know the full story about your family medical history and how well you take of yourself.
Combine your personal knowledge with the helpful tools and information available via the internet and you have the ability to assess your life expectancy with a high degree of sophistication. One excellent tool is the Longevity Game available from the Northwestern Mutual Finance Network. Work through the steps of this interactive calculator with honest answers and you will have a reasoned basis to judge whether the high costs associated with a reverse mortgage can be effectively amortized over your expected remaining life.
- How much additional income do I need?
Presumably you are considering a reverse mortgage because you’ve determined you have an immediate or future need to supplement your retirement income.
Conventional wisdom holds that seniors live on fixed incomes that are continually being eroded by inflation. But government data shows that there is an inverse relationship between aging and spending - in other words, people tend to spend less as they age.
As an example, during the initial years of retirement, many households experience higher spending as long put-off trips, new cars, or other retirement “rewards” are bought. After a few years, though, spending tends to taper off in areas such as entertainment. Retirement spending data from the U.S. Department of Labor Bureau of Labor Statistics illustrates this trend:
If you are looking into a reverse mortgage because of perceived future needs, you may want to consider whether this trend may apply to you. Take a look at friends and relatives and judge whether they seem to be spend less as they age.
In any event, prior to obtaining a reverse mortgage, you should always prepare a budget worksheet. Doing this will accomplish two important goals: 1) help you critically assess your need for a reverse mortgage and, if needed, 2) provide a measure of the monthly income you’ll want to receive from a reverse mortgage.
How much equity do I have and how much can I borrow?
Home equity is the market value of a home minus mortgage debt and other encumbrances. If your home is valued at $175,000 and you have outstanding mortgage(s) totaling $75,000, then your home equity is $100,000.
The home value used in the reverse mortgage process will be determined by a professional appraisal. But in advance of this, you should be able to get a good idea of your homes value by doing a little research using the following free resources:
www.zillow.com. This neat tool will give you tax assessment values and/or recent sales information for your home as well as for other homes in your area all displayed on an aerial photograph or map.
your city or county assessing office
Sunday newspaper home sale ads for your neighborhood
But while home equity is a key factor in determining how much you can get from a reverse mortgage, dont expect to be able to borrow a high proportion of your equity. The likelihood is that your reverse mortgage loan amount will only be somewhere between 35% and 70% of your home equity, depending on the other variables (life expectancy and interest rates) and on the specific reverse mortgage product.
The good news is that now armed with your home equity information, you can visit an online reverse mortgage calculator [http://nrmla.edthosting.com/] to get a more precise handle on what a reverse mortgage can mean to you.
- Have all other options been considered?
Some personal finance experts regard reverse mortgages as loans of last resort – to be used only by seniors facing dire circumstances and who have run out of other options. This may be extreme, but it does beg the question “Have you considered all options?”
Smart consumers need to look at other financial products and strategies that could meet their needs more effectively or efficiently.
- Sell & Downsize
- Sell & Rent
- Move to a Lower Cost Community
- Stay & Rent Part of the Home
- Stay & Cost Share
- Stay & Utilize Traditional Home Equity Financing
- Consider Senior Assistance Programs
- Family-Financed Reverse Mortgage
- Family Payment Assurance
- Consider Tapping Other Financial Assets First
- How important is the goal of leaving a bequest?
A large proportion (as high as 80%) of senior homeowners wish to leave a bequest to their children. For most, home equity represents more than half of their net worth. A reverse mortgage – which uses up home equity – is viewed as running counter to the bequest motive.
Adult children of seniors (the heirs) in many cases see the issue differently. Often these children would prefer their parents use their equity stake to adequately take care of themselves rather than scrimp through retirement for the sake of preserving an estate.
Taking on a reverse mortgage does not preclude the possibility of leaving an inheritance. It does, however, set in motion the process of spending down accumulated home equity. Whether or not there is equity remaining for a bequest is a function of how large the accumulated reverse mortgage grows (including interest accumulation) and how much growth occurs in the market value of the home:
- If the home sells for less than the accumulated reverse mortgage balance, all proceeds go to pay the debt and there is nothing more to pay. A reverse mortgage will never cost more than the value of the home.
- If the home sells for more than the accumulated reverse mortgage balance, the additional equity not used to retire the debt belongs to the estate.
If you believe that a reverse mortgage may be a good option for you (or your parents), you will want to read further about specific program details and features and about the process for getting the loan. Here is a list of excellent free reverse mortgage resources.
About the Author
Tim Paul has more than twenty-five years experience as a finance director. His blog Reverse Mortgage Information, focuses on providing objective and independent information about reverse mortgages.
Article Submitted On: May 26, 2006