The best way to fund retirement is to start saving early and often. Unfortunately, there are millions of Americans that won't have enough savings to meet everyday expenses in retirement. One method some flock to for financial help is the reverse mortgage. Essentially, a reverse mortgage allows homeowners to turn the equity in their homes into an income stream.
Typically, this option comes with significant costs and is not something normally recommended as a first resort. However, if a reverse mortgage is your only option to make ends meet in retirement, you should be fully aware of the requirements and costs involved.
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You may not be eligible for a reverse mortgage. In order to qualify for a reverse mortgage, you must be at least 62 years old, own your home with some equity, and live in the home as a primary residence. In addition, you can't be delinquent on any taxes owed.
Understand your ownership in your home. While a reverse mortgage offers you cash in several payout options for the value of your home, you still own your home and hold the title. You are still responsible for insurance and taxes on your property, as well as any homeowners' association fees, upkeep of the home, and all utilities while you are living in the home.
You can still default on a reverse mortgage. Even though you don't make a payment to the reverse mortgage lender until your home is sold, you can still default if you fail to pay your property taxes, insurance premiums, or any associated homeownership fees. This means you could lose your home if you default and still be obligated to the lender for the loan.
The money must be paid back. There are no monthly payments to the lender for a reverse mortgage, but it's still a loan. Generally, the loan must be repaid within six months after the last surviving homeowner passes away or moves out of the home, or if the homeowner has been in an outside care facility for longer than 12 months. The total amount of the loan must be paid back by the estate with the sale of the home or other assets. This includes all fees that could have been wrapped into the loan. The fees are paid back either by the sale of the home, or, in the event an individual’s home equity is insufficient to cover the balance, by the mortgage insurance proceeds.
Review the fees and closing costs involved. Closing costs such as service fees, origination fees, and appraisal fees often accumulate to a substantial amount. There will also be interest and mortgage insurance premiums, and some companies tack on maintenance fees each year. There is the possibility you may be able to lump the fees into the loan proceeds, but keep in mind the old adage, "There are no free lunches." Just because you aren't paying the fees up front doesn't mean you won't be paying over the long-term.
Reverse mortgages are not for everyone and should probably be considered only as a last resort. As with any investment, check the fine print regarding payback terms, fees, interest rates, and home value before signing anything.
If a deal seems too good to be true, well, you know the drill.
Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets including FOX Business, USA Today and The Wall Street Journal. Keep tabs on Scott on Twitter and Facebook.
Clarified 8/9/2011: A previous version of this article was unclear about the repayment terms of reverse mortgages. An individual's other assets and those of their descendants cannot be pursued if home equity is insufficient to cover the loan balance.