Older homeowners who are ready to say goodbye to the burden of a mortgage payment may consider paying off their traditional home loan using their home’s equity — through a reverse mortgage.
Reverse mortgages have gained a somewhat dubious reputation over the years, but they can be a useful financial tool for seniors when used appropriately, says David Johnson, associate professor of finance at the Maryville University in St. Louis.
1. Reverse mortgage
A home equity loan in which the borrower is not required to make payments. The homeowner must be at least 62 years old. A reverse mortgage accrues interest and doesn’t have to be repaid until the homeowner dies or moves out of the house. The Federal Housing Administration, or FHA, calls it a HECM, for home equity conversion mortgage.
Not only for the desperate
“Years past, financial planners didn’t view reverse mortgages as a planning tool,” says Johnson, who co-authored a study discussing the growing importance of reverse mortgages in retirement. “It was viewed as a last resort, and they assumed that the only people that do reverse mortgages are people that are desperate. Clearly that’s not the case, and I think they are starting to view it differently now.”
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Why get a loan when you already have one?
One of the most common reasons homeowners get a reverse mortgage is to pay off their existing mortgage so they have more income to work with, says Maggie O’Connell, who runs ReverseMortgageStore.com.
“They already have this debt on the house, so instead of making their mortgage payments, they are just paying it out of their equity before they leave the home,” she says.
What it takes to get a reverse mortgage
To qualify for a reverse mortgage, the homeowner must be at least 62 years old and have sufficient equity in the house. The size of the loan depends on the value of the home, the age of the youngest borrower and how much is owed on the house. The owner must pay property taxes and insurance.
2. Hypothetical examples of paying off a mortgage with a reverse mortgage
Robert is married to Linda, who at 62 is the younger spouse. Their house is worth $200,000 and they owe $62,000 on the mortgage.
Based on their ages and the home’s value, they can get a reverse mortgage for up to about $104,800. This is known as the principal limit or maximum loan amount. Closing costs, including FHA initial mortgage insurance, reduce that available amount to about $93,800.
Under FHA rules, the amount they borrow is limited in the first year. Borrowing the $62,000 to pay off the mortgage, they can take out another $10,400 in cash during the first year. A year later, the remainder is available to them.
Barbara is a 75-year-old widow with a house that’s worth $400,000. She owes $25,000 on a home equity line of credit, with no other mortgage debt.
Based on her age and the home’s value, she can get a reverse mortgage for up to about $245,600 (the principal limit). Closing costs, including FHA initial mortgage insurance, reduce the available amount to around $234,900.
Under FHA rules, she can get a reverse mortgage, pay off the HELOC balance and take out up to around $111,600 in cash during the first year. A year later, the remainder would be available to her.