Designed for people 62 and older, reverse mortgages enable you to have a bank buy your home while you're living in it. It provides an income that you can receive in a lump sum, a monthly payment or a line of credit.
Sounds kind of like winning the lottery, right? Not quite. You have to pay the money back (plus interest) when you vacate or sell the home, and there are fees. Still, these mortgages have a place. A report by the AARP says that while only about 1 percent of older homeowners have a reverse mortgage, 107,000 were loans made in 2007 compared to 6,600 in 2000.
Consider these things:
Your age. These aren't for everyone, but the older you are, the more likely you are to benefit from one. For one, you probably have more equity in your home. But the other reason is that banks calculate the payout based on not only the value of your home, but your age and average expected length of life.
"If you're 75, you could get a much more adequate stream of income than if you're 65. That's because the bank would estimate that if they're starting to pay at 65, they'll have to pay for a longer period of time," says John Rother of AARP.
Your situation. A reverse mortgage probably isn't for you if you're not planning to stay in your home for a long time. Think about other factors related to your current and future lifestyle. People get these loans for a variety of reasons, says Peter Bell, president of the National Reverse Mortgage Lenders Association. Some do it to finance an active lifestyle in their retirement, others because the home needs to be repaired or updated with health care equipment.
"Let's take a 75-year-old widow who's lived in this home for some time, but it needs substantial repairs. If she doesn't have any other way of financing those, then a reverse mortgage might be an appropriate way for her to stay in the home, keep it in good shape, and continue to enjoy it," Rother says.
If you're hanging on to this home because you think your children will want to live in it, have a discussion to make sure that's the case. If it's not, consider downsizing to something smaller and more manageable.
The alternatives. As I mentioned, one might be moving into a smaller, less expensive home or cutting back on your expenses. But if you've made all possible cuts to your budget and still need some extra income, research benefit programs you may be eligible for from your state, the federal government or your former employer. Look into a home equity loan or line of credit, depending on if you need the lump sum or just want to have some money available in case of an emergency. The one silver lining of the probable recession is lower interest rates.
The fees and interest rate. These mortgages are paid back when the home is sold, typically as a result of the borrower moving or passing away. The fees, also paid at that time, tend to be higher than those associated with a traditional mortgage. Bell says the exact figures vary by product, but typically average 5 percent of the home's value.
"When they sell, what they owe is the sum of the funds that have been advanced, the fees that were associated with the loan, and any interest that was accrued on it. But that's capped by the value of the house," Bell says. If the amount owed is more than the value of the house, the lender eats the difference. If it's less, you (or your heirs) keep the change.