Reverse mortgage funding may sound like a good idea but these five alternatives will save you thousands and protect your home
One of the biggest decisions as you head into retirement is where you’re going to live. You’re probably looking at lower income for the next few decades and may not be able to afford your monthly mortgage payments.
Then you see your old pal Alex Trebek on TV, talking about a way to stay in your home and not make payments for the rest of your life.
Jeopardy wouldn’t steer you wrong, would he?
It’s called a reverse mortgage and there’s a lot to like about the pitch. You get a loan on your house that requires no payments for the rest of your life.
Sounds almost too good to be true.
I’m as much a fan of the mustachioed-Canadian as anyone but there are some things you need to know about reverse mortgages before you dial that phone number.
It turns out, it might be a quick way to get yourself into double jeopardy!
What is a Reverse Mortgage?
A reverse mortgage is a type of loan on you home but with a special payment plan. It’s a program signed into law by President Reagan and formerly known as the FHA-insured Home Equity Conversion Mortgage (HECM).
Reverse mortgages are only available to homeowners 62 years and older on primary residences of one- to four-unit residential property as well as manufactured homes as long as they meet FHA standards.
The difference between a reverse mortgage and a regular mortgage on your home is that there are no payments while you’re alive. Just like in a refinance, the lender cuts you a check for the amount of the loan minus whatever is needed to pay off the existing mortgage. Interest builds on the loan every month even though no payments are due.
The lender holds the loan until the borrower and spouse dies, sells the house or moves out for more than 12-months. The home passes through to the estate but the mortgage comes due which means heirs can either pay off or refinance the loan, sell the house or let the lender sell the house.
- Only available to homeowners 62 years and older
- Available only on your primary residence
- Potential to receive cash from the loan and make no payments for the rest of your life
- Interest accrues on the loan and comes due when last borrower passes or moves out
- Estate can choose to pay off the loan, refinance, or sell the house
How Does a Reverse Mortgage Work?
The process for getting a reverse mortgage is easy, almost too easy.
You first have to undergo a financial assessment to make sure you have enough income to pay property taxes and other monthly expenses. You also must have made all mortgage and installment debt payments on time for the last 12 months and not have been more than 30-days late on your mortgage more than twice in the last two years.
The reverse mortgage lender will coordinate an appraisal to check how much your house is worth and how much you still owe on the mortgage. To qualify for a reverse mortgage, you’ll usually need to have paid down your mortgage to about 60% of the home’s value or less.
You’ll be shown how much the lender will offer as well as an interest rate and fees. These are important and we’ll talk more about them in a bit.
If the loan amount offered is more than you owe plus fees on the reverse mortgage, you have a few different options on how you want to take the extra money.
- You can take it all at once, in a Lump-sum.
- You can take the money in equal monthly payments over a set number of years
- You can open a line of credit, basically a savings account on which you can draw money when needed
Why do you need so much equity in your home to get a reverse mortgage?
While you can usually get a refinance mortgage with as little as 10% equity in your home, that’s the home’s value minus the total amount you owe, it’s different for a reverse mortgage.
You’ll need to have a lot more equity for an HECM. In fact, you usually need to owe about half of what the house is worth or less.
It’s because you aren’t going to be making payments for years, maybe decades, on the loan. All the interest is just going to keep adding up on top of the loan amount.
If that added interest plus the loan amount is more than the house is worth when the loan comes due, there’s a good chance the lender isn’t getting its money back. The heirs might not be able to sell it for enough to pay off the loan and the bank won’t get that much out of it either.
To avoid this, reverse mortgage lenders will only lend about half of what a home is worth. That way, even after all those years of interest add up, it can still sell the house and get the money it’s owed on the loan.
Why Reverse Mortgages are a Scam
A reverse mortgage might sound like a great idea. Stay in your home, not make any loan payments for the rest of your life and maybe even get a little cash out of the deal.
What’s not to like?
The biggest problem in a reverse mortgage is the cost. Whereas a refinance mortgage might cost you a total of 2.4% in lender and third-party fees, a reverse mortgage can easily cost 5% of the loan amount.
Example: For a $200,000 loan, you could be looking at costs of $4,800 for a traditional refinance compared to $10,000 for a reverse mortgage.
Fees include the counseling fee ($125), origination fee by the lender (1% to 2.5%), third-party costs for the appraisal, title insurance, escrow, recording tax, etcetera.
Not only are fees much higher for a reverse mortgage but the interest rate is usually higher and you’ll pay other annual fees as well. These annual fees like mortgage insurance and servicing costs will be added to your loan balance, making it still harder for your heirs to save the house when the loan comes due.
Let’s look at the difference between a reverse mortgage and a $160,000 refinance loan. The current average rate on a 30-year fixed refinance is around 3.6% while the average on a reverse mortgage is about 4.8% plus the 1.25% annual mortgage insurance charge.
The comparable payment on the reverse mortgage would be $964 a month versus the monthly payment of $727 on the refinance. Since you don’t make those payments on a reverse mortgage, we’ll add all the interest into the refinance loan as well to see how much more you would owe at the end of 30 years.
I’ve added loan costs of $5,000 into the refinance and $10,000 into the reverse mortgage per averages for this size loan.
A reverse mortgage is more than twice as expensive as a regular refinance mortgage!
All this means you’re probably not going to get the kind of cash out of your home as you might think in a reverse mortgage and your heirs could have a very tough time saving it when they have to pay off the loan.
Basically, if you don’t care about what happens to your home after you die, then a reverse mortgage might be an option. Otherwise, you might want to consider some of these options.
Looking at the pros and cons of reverse mortgage funding, you get a quick sense that it might be more trouble than it’s worth. The long list of disadvantages means you should at least consider some of the alternatives to reverse mortgage funding.
Best Alternatives to a Reverse Mortgage Funding
There are better alternatives to a reverse mortgage that can still give you the benefit of no payments. They can do the same thing as a reverse mortgage but cost far less and keep your home from going to the bank later on.
Refinance existing mortgage – You might not have much of a choice if you haven’t paid most of your mortgage off. If you owe more than 60% of your home’s value then you won’t qualify for a reverse mortgage.
A regular refinance can be just as good. You’ll pay about half the loan costs and can get a better interest rate. Put the money you get out of your house in very safe investments like high-quality corporate bonds and take money out of the account each month to make the mortgage payment.
Money from your investment account will pay the mortgage for more than a decade, at which time you can always refinance again or try one of the other reverse mortgage alternatives.
If you just need a personal loan or money to pay living expenses, you can save thousands versus a reverse mortgage by using a signature loan. Unlike reverse mortgages and traditional mortgages, signature loans do not require signing away your home as collateral.
That means you can’t lose your home if you miss a payment. These loans offer lower fees compared to reverse mortgages.
I’ve included a table here of personal loan and signature loan websites I’ve used or reviewed. You’ll need a higher credit score with some but can get lower rates while others specialize in bad credit loans. Shop around to make sure you get the best deal possible.
|Peer to Peer Lending Site||Loan Fees||Credit Score Needed||Loan Rates||Notes|
|5%||580||9.95% to 36.0%||Best p2p loan site for bad credit borrowers. Lower credit score and three options including peer loans, bank loans and personal loans.|
|No Fee||Not available but higher than most, around 680 FICO||5.99% to 16.49% (fixed rate)|
5.74% to 14.6% (variable rate)
|Special discounts for variable rate loans. Offering $100 cash back on peer loans.|
|1% to 6%||620||6.25% to 30.0%||Best peer loans for graduates and no credit history.|
|No Fees||520||Vary by State||No fees and lowest credit requirements for lenders|
|1% to 6%||640||6.95% to 35.89%||Low rates on p2p loans for good credit borrowers.|
Home equity line of credit (HELOC) – This is where you just take out a loan on the equity you have in the house but without paying off the primary mortgage. You’ll have two mortgage payments to make but can use the HELOC money to make both payments for years.
HELOC rates are usually a little higher than the rate you’ll get on a traditional refinance but costs are much lower.
Sell and downsize – If you’re trying to cut costs and stress in retirement, you might think about just finding a smaller home. I know there are a lot of memories in the home where you raised your kids but those memories go with you. Do you really need four bedrooms and three baths for just two people?
The money you get out of selling your home can easily cover the monthly costs of renting or even buying a smaller place. Again, invest the money in safe bonds or other fixed income investments so you don’t have to worry about a stock market crash.
Sell home to children on the condition that you get to live there without payments. Sell it to them for the amount you owe on the loan plus selling costs and everyone wins. You get to ditch your mortgage payments and they get all the equity you’ve built up.
This is a great option that’s essentially the same thing as a reverse mortgage except without the thousands in extra fees. You won’t have to pay the realtor fees you would have if you sold the home or the huge lender fees from a reverse mortgage.
Personal loan – If you just need some money to get by, you might consider taking out a personal loan or a debt consolidation loan. The rate on a personal loan will be higher than on a mortgage but you’ll save thousands compared to the closing costs in a reverse mortgage.
A personal loan also has the added benefit of not bringing a lien on your home. If you’re not able to repay the loan, you don’t have to worry about the bank taking your home. I’ve used PersonalLoans.com and SoFi for personal loans and recommend them both.
DIY Reverse Mortgage Alternative
Refinancing or selling your home to family can be a great alternative to reverse mortgage.
Refinancing as an alternative would mean taking the cash equity out of your home and putting it in a savings account used to make monthly payments on the new mortgage. Interest rates are at historic lows and payments on a 30-year loan should be low enough that you can draw from this savings account for up to a decade or more.
The refinancing alternative comes with the added benefit that you continue to build equity in your home. When the home goes into your estate, it has some value saved rather than being maxed out like with a reverse mortgage. That’s going to make it easier on your heirs to either pay off the loan or sell the home.
With this alternative, you save the $10,000+ in reverse mortgage costs and fees. That’s money you can use to make payments on your home refinance or pay for living expenses.
Can I Get Out of a Reverse Mortgage?
About the only way to get out of a reverse mortgage is to pay off the loan balance. That’s tough to do without selling your home so you might be stuck right back where you started.
Even if you can get the money together to pay off your reverse mortgage, you will have also paid tens of thousands in fees and other costs. That’s really where reverse mortgage lenders get you and they take that money off the top.
That’s why it’s critical that you understand the details behind the program and explore any alternatives to reverse mortgages that might better fit your needs. For most people, a short-term portfolio loan can get them over quick cash needs. Refinancing your home and then using the cash to make payments over the next decade is generally the cheapest alternative and comes with the benefit of staying in your home.
A reverse mortgage may sound like a great idea but the hidden fees and thousands in extra costs make it a poor choice. The only ones that wins in a reverse mortgage are the lenders, agents and other people collecting all those fees. Consider these five cheaper alternatives to a reverse mortgage to save money and protect your home.