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Subject: |
Reverse Mortgages |
| Date: |
2002-08-25
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Reverse Mortgages
The Dollar Stretcher
by Gary Foreman
gary@stretcher.com
Gary,
I am almost 80 years old, a widow, excellent health, no debts, my house is
paid off, worth close to $200,000. I live on my social security with a
small savings backup, and I manage to make my taxes and maintain a car and
live well.
My children think I should take out a reverse mortgage and spend the money
doing some traveling. As they are all doing well and do not expect or want
me to just save the house for them. Are there any pitfalls in this?
Betty
Yes, Betty, there are some pitfalls. Any time that you put your home up to
secure a loan there are dangers. They may be reasonable risks to take, but
you need to know them. Let's take a moment to understand reverse mortgages.
Then we can better explore the risks and benefits.
A reverse mortgage seems strange at first. The purpose of a reverse
mortgage is to convert the equity in your home into cash.
Like a regular mortgage, you're borrowing against your home. And, when you
sell you'll need to repay any balance on the mortgage. But instead of
borrowing all the money at the beginning and then paying it back each
month, this time you'll borrow a little at a time and not repay the
mortgage until the house is sold. In that way it's the reverse of a
traditional mortgage.
Now the risks. The first problem is that they're somewhat complicated. And
that can be a real issue for borrowers as they get older. Betty might
understand everything today. But it's not unreasonable to expect that she
won't be as sharp mentally in ten years.
Then there are expenses much like a regular mortgage. Betty's house will
need to be appraised. There will be an origination fee.
If Betty does borrow against her home, she needs to maintain enough equity
for future needs. Her monthly living expenses could increase faster than
her income. Or she might need to move into a nursing home. Her home is her
only significant financial asset. She needs to guard it's value carefully.
One payout option allows you to take fixed monthly payments for the rest of
your life. That does protect you from losing your home during your
lifetime. But it also means that you'll only get the fixed income amount.
And inflation can shrink fixed income streams. The other disadvantage is
that you might not live that long. The mortgage company could be 'buying'
your house fairly cheaply.
Once Betty takes out a reverse mortgage she can pretty much expect to have
it until she sells the home or dies. The reason is simple. She's unlikely
to have enough money to pay off the mortgage without selling the home.
So what are the benefits to a reverse mortgage? A reverse mortgage would
allow Betty to borrow against her equity as often as she likes. She could
borrow for a trip or any unmet living expenses.
Since she's borrowing the money it's not considered taxable income to her.
That can make a reverse mortgage better than selling stocks that have
appreciated. Any stock gains will trigger income taxes.
If Betty wants to get a reverse mortgage she'll need to meet with a HUD
approved counselor before you can get a reverse mortgage. You'll find a
list of approved counselors at
http://www.hud.gov/offices/hsg/sfh/hcc/hccprof14.cfm
Before she actually applies for a loan and incurs those costs, Betty should
compare the rates to other sources of cash. The closer to age 62 the easier
it is to find other cheaper places to borrow.
Betty might want to check out something called the "Home Equity Conversion
Mortgage" (HECM). It's a federally insured mortgage. For more information
she can call HUD at 1-888-466-3487
She'll need to decide whether she wants a one time payout, the ability to
borrow whenever she wants, or a set monthly payout. Single purpose loans
are generally the least costly. But over 60% of homeowners choose to use a
line of credit type payout.
Ultimately the home will be sold. At that time the value of the home will
be broken into three parts: the amount borrowed, the costs associated with
that borrowing and leftover equity that will go to Betty or her estate.
The best way to compare reverse mortgages is to answer three questions
about each mortgage. How much money would you get? How much would it cost
you? And how much equity would be left when you sell or die?
Should Betty use a reverse mortgage? A little travel sounds nice. But she
might find a home equity loan a little easier to manage than a reverse
mortgage.
Gary Foreman is a former Certified Financial Planner who currently edits
The Dollar Stretcher website www.stretcher.com copyright 2002, Dollar
Stretcher Inc. All rights reserved. Permission granted for use on DrLaura.com
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