I Sign the Line & Get a Big Pile of Money – How Bad Can it Be?
Many retirees in need of fast cash are asking themselves, “Should I get a reverse mortgage?”
If you’re in this boat, it may be interesting for you to know that reverse mortgages have actually been around since the 1960’s, and for the first 4 decades of their existence represented only a small handful of mortgage originations in the US.
Then, during the housing crisis in the late 2000’s, reverse mortgages boomed and reached a peak of almost 120,000 in 2009. The number of new reverse mortgages has declined rapidly since then, which is probably happening as people discover the pitfalls associated with these products.
Read on for 4 reasons to avoid these products followed by 4 alternatives for retirees to consider to generate the cash they need in their golden years.
Reason to Avoid #1 – You Don’t Qualify
This one is not an inherent flaw with reverse mortgages, but we may as well start here. In order to qualify for a reverse mortgage, you need to be:
- 62 years old
- Have significant equity in your home
- Be living in the home as your primary residence.
If you don’t meet all 3 of these qualifications, you can skip the remaining 3 “Reasons to Avoid” and jump right down to the 4 alternatives for retirees to free up cash for living expenses or unexpected bills.
Reason to Avoid #2 – High Fees
Fees with reverse mortgages are often high. In some cases they are triple those of a traditional mortgage. This situation is improving however; and it is now possible to find lower fee reverse mortages products. You’ll just need to shop around to do so.
Reason to Avoid #3 – High Interest Rates
In addition to higher fees on the front end, interest rates for reverse mortgages are also typically somewhat higher than a traditional mortgage and usually significantly higher than a Home Equity Line of Credit (HELOC).
It’s great to get that lump sum or monthly check in the mail that comes your way when you take out a reverse mortgage, but it’s also likely coming to you at a high cost.
Reason to Avoid #4 – What Happens When the Loan Comes Due
With a traditional loan, you buy a large asset like a house or a car, the lender fronts the money and you make a regular monthly payment to repay the loan.
Reverse mortgages are different in that you take out the loan and the lender sends the money directly to you, either as a lump sum or as a monthly payment.
Make no mistake – even though this behaves differently than a traditional loan, it is still a loan that needs to be repaid at some point. Triggering events include either you passing away or if you move out of your home. In either case, the money will need to come out of your estate and/or any remaining equity in your home leaving less money to pass along to your children or other heirs if that’s something you want to do.
So Now What?
I’ve given you a bunch of reasons not to go pursue a reverse mortgage, but we haven’t solved your problem because you still have a need for cash. Here are 4 alternatives to consider:
Alternative #1 – Apply for a Home Equity Line of Credit
If you have significant equity in your home and decent credit, you should have no problem qualifying for a Home Equity Line of Credit (HELOC). Once you establish your HELOC, you can draw out any amount up to your credit limit.
Credit limits are typically established based upon the Loan-to-Value (LTV) Ratio, with banks typically being willing to lend between 70-80% of the LTV. Let’s look at a simple example to see what your credit limit might look like when applying for a HELOC.
Let’s assume that:
- Your house is worth $100,000.
- You have $60,000 in equity in your home or 60%.
- You owe $40,000 or 40% of the value of your home within your first mortgage.
- Your bank will limit the size of your loan at a combined 70% LTV when looking at your first mortgage and HELOC.
Given this scenario, the bank will not want the combined total of what you owe on your first mortgage (which is $40,000) and your HELOC to exceed $70,000, which is the 70% LTV on a $100,000 property.
This implies that the maximum HELOC you’d qualify for in this scenario is $30,000. ($70,000 – $40,000 = $30,000).
Once you establish your HELOC, you can draw out any amount up to your credit limit and make interest-only payments for the term of the loan. You can also repay any principal you’ve drawn out along the way – you do not need to wait until the end of the loan term to do so.
Loan terms are typically anywhere between 5 and 20 years in duration. Once you get to the end of the loan term, all outstanding balances must be paid in full.
Alternative #2 – Downsize
This may not feel like a great option, particularly if you love your current home. However, if you’re looking at a 30 year retirement and have other goals you want to fund (travel, hobbies, etc.) this is a great option to free up extra cash in terms of:
- Any capital gain you realize on the sale of your home.
- A reduced mortgage payment (if you still have a mortgage).
- Lower monthly expenses associated with a smaller residence.
Alternative #3 – Move to a Lower Cost of Living State
If you’re not tied to a particular location, this is a great opportunity to trim expenses while staying in a similarly sized house if that’s important to you. Check out this list of the 20 most affordable cities in the US and this article for the 10 least expensive states to call your new home.
Alternative #4 – Embark Upon Your Encore Career
Retirement at 62 made complete sense financially when average lifespans were typically around 70. If you’re 60 and reading this article, it’s highly likely you’re going to live well into your 80’s or 90’s.
Working in retirement is becoming increasingly common with a recent Merrill Lynch study reporting that 70% of pre-retirees plan to work at least part time. This is a great opportunity to not only pursue a new and more fulfilling line of work, but also to shore up your retirement finances as well!
Originally shared on Investopedia