You Decide

A primer on reverse mortgages

December 6, 2013 

Robert Wagner, Henry Winkler and Fred Thompson are actors. Wagner’s career has spanned half a century in both film and television. Winkler is best known as the Fonz on TV’s “Happy Days,” and Thompson has sandwiched an acting career around a stint in the U.S. Senate.

Besides acting, the trio has something else in common. They are spokesmen for companies offering a financial product called a reverse mortgage. But what exactly is a reverse mortgage, and is it something you should consider?

To start, let me first talk about a traditional mortgage. A mortgage is simply a large loan used to buy a home. Such a loan can easily total several hundred thousand dollars, and the loan is secured by the value of the home. That means if the buyer can’t make all of the loan payments, the firm making the mortgage can take possession of the home.

The home buyer, by making monthly payments, usually repays the mortgage over a long period; 30 years is common. Each payment has a part that reduces the amount of the loan and a part that pays interest on the loan. If the home buyer sells the home before completely repaying the mortgage, proceeds from the home’s sale will be go to pay off the remainder of the loan. If the home’s value isn’t sufficient to repay the mortgage, then the home is said to be “underwater,” and the owner obviously faces a financial problem.

If a homeowner is 62 or older and owns a home free and clear of a traditional mortgage, the owner can consider a reverse mortgage. The name is based on the fact that the circumstances for a reverse mortgage are the opposite of the circumstances for a traditional mortgage. In a reverse mortgage, the person owns the home with no outstanding loan; in a traditional mortgage, the person is buying the home and uses a loan (debt) to do so.

For a reverse mortgage, the person receives money; in a traditional mortgage, the person pays money. And although this certainly isn’t always the case, people using a reverse mortgage are often near the end of their lives, while users of a traditional mortgage are much younger.

A reverse mortgage is a way for the homeowner to draw money from the home’s value while still living in the home. In this way, it is similar to a home equity loan or a second mortgage. But compared to these two financial products, the reverse mortgage has two distinguishing features. First, repayment of the money received by the homeowner will usually come from the future sale of the home after the owner leaves.

Second, the payments received by the homeowner usually come monthly and last for a long time – sometimes until the owner dies. In the case of lifetime monthly income, the probabilities of the owner dying in different years (the same factors used in life insurance calculations) are used to determine the monthly amounts.

Why would a 62-and-plus-year-old homeowner consider a reverse mortgage? If such a homeowner has a need for additional monthly income and has no other good options for obtaining that income, then a reverse mortgage might be the answer. The additional monthly income could pay for normal household expenses, or maybe premiums for a long-term health-care policy or just for fun activities, like trips.

When considering a reverse mortgage, remember that the homeowner will still be liable for property taxes and for maintenance and repair expenses on the home. And as with a traditional mortgage, there will be upfront fees and other expenses the homeowner must pay when obtaining a reverse mortgage. The financial firm will also charge an interest rate and subtract interest costs from the monthly income paid to the homeowner. The financial firm charges interest because it is paying the homeowner money now but won’t be repaid until later.

Homeowners considering reverse mortgages should shop competing financial companies and compare their terms for the fees, expenses and interest rate.

Here is, perhaps, the blockbuster realization for considering a reverse mortgage. Use of a reverse mortgage means a significant part – perhaps all –of the home’s value won’t be available in the homeowner’s estate. Statistics show a home is the largest financial component of many households’ estates. Many homeowners who are parents understandably want to pass their home’s value on to their children. A reverse mortgage reduces the ability to do this. Some surveys show that children of homeowners are overwhelmingly opposed to reverse mortgages.

So where does this leave you in deciding if a reverse mortgage is for you? If you’re elderly (like me), own your home with no loan, would like to have some additional monthly income and understand your children will be inheriting less, then a reverse mortgage might be a wise move. But do your homework first and compare fees, interest rates and other terms.

I like Bob (Wagner), Henry (Winkler) and Fred (Thompson) as actors, but let’s face it, they aren’t financial advisers. So when it comes to reverse mortgages, you decide how the pluses and minuses add up.

Dr. Mike Walden is a professor and N.C. Cooperative Extension economist in the Department of Agricultural and Resource Economics at N.C. State University.

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