Is a reverse mortgage only for broke and desperate people? Many people seem to think so, but I respectfully disagree.
A reverse mortgage can sometimes help broke and desperate people, but often it can’t. The reason? You have to qualify for a reverse mortgage. Your income and credit must meet certain standards or you won’t be eligible for a reverse mortgage.
I would argue that a reverse mortgage is best used as a safety net by seniors who are at least reasonably financially stable. In my opinion, the most ideal candidates tend to fit two general profiles – which I’ll cover in a minute.
Before we dig into that, let’s first go over a few basics about how a reverse mortgage works.
How does a reverse mortgage work?
So what is a reverse mortgage? The most popular reverse mortgage in America today is the home equity conversion mortgage, or HECM. The HECM is a federally-insured reverse mortgage that enables homeowners 62 or older to convert a portion of their home’s value into cash.
No mortgage payments are required as long as at least one borrower or non-borrowing spouse is living in the home and paying the required property charges.
You always remain the owner of your home and you’re free to leave it to your heirs. Your heirs will inherit any equity remaining in the home.
The HECM reverse mortgage is a non-recourse loan. That means the most that will ever be repaid is the value of the home. If the value of the home is not worth enough to pay off the entire loan balance, FHA will cover the shortage. You’ll never leave a debt for your heirs to pay off.
HECM proceeds can be received in the form of term or tenure payments, lump sum at closing, line of credit, or some combination of all three options.
Reverse mortgage borrowers commonly use the proceeds to get rid of existing mortgage payments, pay off other debts, finance home improvements, or supplement existing retirement income or assets. You can use the cash for pretty much whatever you need.
Many applicants don’t qualify
In 2014, FHA implemented new guidelines to help screen out borrowers with poor credit and financial profiles. Called financial assessment, the guidelines require lenders to assess income and credit when qualifying applicants.
Prior to the change, almost anybody could get a reverse mortgage regardless of income and credit. If an applicant was at least 62 and had significant home equity, they likely qualified. Unfortunately, the relatively loose lending guidelines at the time led to a high default rate, which led to bad outcomes for borrowers and negative headlines for the program.
Financial assessment was designed to weed out high risk borrowers and reduce defaults due to nonpayment of property charges.
Borrowers with poor qualifications can still get a HECM, but they’ll be required to take a LESA, or life expectancy set aside. A LESA sets aside a chunk of the proceeds to pay property charges for the rest of the borrower’s expected life span (based on government life expectancy tables). FHA is willing to let borrowers with shaky credit or tight cash flow to get a reverse mortgage, but they’ll insist on a LESA to make sure property charges are paid.
Many borrowers find the LESA attractive because it means they don’t have to worry about paying property taxes and insurance. However, there needs to be enough money available in the reverse mortgage to set up the LESA or the borrower won’t qualify.
For example, if the net principal limit (the total pool of money available after paying existing mortgage balances, closing costs, etc.) is $200,000 and the borrower has a $190,000 mortgage balance, there is only $10,000 available to set up the LESA. Unless the property taxes and insurance are inexpensive and/or the borrower is very old, there likely isn’t enough money available in the reverse mortgage to pay off the mortgage and set up the LESA.
The ideal HECM reverse mortgage candidate
The ideal candidate for a HECM reverse mortgage is somebody who is already reasonably financially stable. Such candidates have at least a modest income and some assets and want the reverse mortgage for additional flexibility and security. Ideal candidates want to use the reverse mortgage as a safety net, not as a last resort.
Ideal candidate #1
If you have many years left on your mortgage and have no plans to sell your home, you are a prime candidate for a reverse mortgage.
Think about it: if you have 28 years left on your mortgage and you’re likely to live only 20 more years, why continue paying on a mortgage you may never pay off anyway?
If you have no plans to sell your home, you’ll never realize in any tangible way the equity in your home. It’s just a number on paper that has no real impact on your lifestyle.
Why not put that equity to work and get rid of your mortgage payment? You can free up cash to use for other purposes, like building savings, traveling, or doing home improvements.
If you’re drawing on retirement assets and paying a mortgage, the reverse mortgage can help you protect and preserve your assets for longer. FAR Vice President of Retirement Strategies Steve Resch mentions this strategy in an article by Chris Clow over at Reverse Mortgage Daily:
In one case, [a retirement strategies symposium] attendee was taking a 6% asset distribution in part to cover a costly mortgage payment. “Now, these people aren’t broke,” Resch explains. “This couple had $2 million in invested assets. […] So, simply by eliminating that mortgage payment, we’re able to reduce the asset distribution rate down to about three-and-a-half percent, which helps the assets to continue to grow and provide longevity to the estate.”
The people Resch describes, by all accounts, are already financially stable. In fact, they are quite wealthy. They chose to use a reverse mortgage to get rid of a mortgage payment that was being paid by proceeds from a retirement account. By reducing the drain on their assets, they’re protecting and preserving them for longer.
Again, the reverse mortgage is being used as a safety net to help protect and preserve retirement assets.
Ideal candidate #2
If you owe little to nothing on your home and don’t need the money from a reverse mortgage right now, you’re also a prime candidate. In your case, I recommend getting a reverse mortgage immediately and taking the proceeds as a line of credit.
The HECM line of credit is fantastic because it essentially converts a portion of your home’s value into a tax-free retirement account that grows and compounds larger.
Remember, if you have no plans to sell your home, home equity is just a number on paper that has no real impact on your life. After all, you can’t exchange home equity for cruise tickets or a nice steak dinner, right?
The reverse mortgage line of credit enables you to convert home equity into cash without a mortgage payment or giving up ownership of the home.
So, how does the reverse mortgage line of credit work? Well, it’s very similar to a traditional home equity line of credit (HELOC), but far better because it requires no mortgage payment as long as you meet your program obligations.
Even better, the available credit line grows based on an annual growth rate. The growth automatically gives you access to more equity over time.
If you owe little to nothing on your home and don’t need the money from the reverse mortgage right now, you can maximize the growth of the line of credit. By the time you actually need the money, you’ll have a lot more available than what you started with.
For more information about the HECM line of credit and how it grows, check out my article on the topic here.
Not a loan of last resort
Contrary to popular belief, a reverse mortgage is not a loan of last resort. It’s not a loan only for desperate and broke people because such people often don’t qualify. The HECM reverse mortgage is best used as a safety net by seniors who are at least reasonably financially stable.
If you’re a financially stable senior and you have a good amount of equity in your home, a reverse mortgage can free up the equity in your home so you can live a better and more financially secure retirement.
If you’d like to find out how much you can get from a reverse mortgage, check out our free reverse mortgage calculator here.