Homeowners over the age of 62 who have built up a considerable amount of equity in their home—but have no plans on selling and wish to stay—could tap into their housing wealth with a reverse mortgage.
This type of mortgage has become a popular way for baby boomers
to fund their retirement: $15.3 billion of such loans were taken out in 2013, an increase of 20% over 2012, according to a New York Post article
This may sound like a sweet deal for retirees, but a reverse mortgage comes with numerous drawbacks and should only be considered by a select group of people.
What is a reverse mortgage?
With a reverse mortgage, older homeowners can borrow money against the equity in their home if they either own their home outright or have a small existing mortgage.
Instead of you paying it back each month like a typical home loan, the bank paysyou
, and the loan only has to be repaid when you sell the home or move out, or after your death.
You can receive the money as a lump sum, a monthly payment or a line of credit, and the amount you can borrow ultimately depends on your total equity, your age (you must be at least 62 to qualify), the length of the loan term and current interest rates.
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The ups and downs
There are a few potential benefits to a reverse mortgage. Mainly, you can convert equity into cash without selling your home. This means money in your pocket to help fund your retirement.
You also don’t need to have a job, steady income or even good credit to get approved, according to Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage.”
And then there are the drawbacks.
Fees can be very high, and include origination fees, service fees, a mortgage insurance premium and closing costs.
In the event of your death, the home will have to be sold to repay the mortgage, so it likely cannot be passed on to your heirs unless they can repay the balance owed. You’ll also have to repay the loan if you move out of the house and have not lived in it for more than 12 months. This includes if you enter a long-term care facility, according to U.S. News & World Report.
Since you still own the home, you will be responsible for property taxes, insurance, maintenance and other expenses. If you fail to repay these regular expenses, you could end up forfeiting your home.
“Reverse mortgages have their place, but the problem is that they’re sold to people who shouldn’t have them because it doesn’t work for them,” says Craig Smalley
, a financial adviser and certified estate planner based in Orlando, Fla. “They are for those that have little or no retirement funds, and have no heirs really to speak of.”
Unfortunately, there are few options other than a reverse mortgage to access your home equity.
You could take out a new mortgage on your home and receive a lump-sum payment, a process also known as a cash-out refinance, or take out a home-equity loan
or line of credit. You’ll likely receive a better interest rate and terms than you would on a reverse mortgage, plus you’ll likely be able to deduct mortgage interest on your taxes.
On the downside, you’ll need to pay back every penny you borrow, or you may default on the mortgage and forfeit your home. You also must qualify for a new mortgage, which means you’ll likely need a good credit score and a source of income. If you choose a home equity line of credit, or HELOC, your interest rate will likely be variable, which exposes you to interest-rate risk.
If you need cash and have substantial equity in your home, a reverse mortgage may sound like a sweet deal. But this is an expensive borrowing option that comes with more than a few drawbacks. Be sure to consider all of your options before making a decision.