According to Investopia, Baby Boomers (born between 1946 and 1964) are heading into retirement in droves. Approximately 10,000 Boomers retire per day.

Much of the data concludes that this generation is poorly prepared for their later years. As we know, relying on social security alone may not provide enough money to live the lifestyle we once hoped “The Golden Years” would afford us.

The hope is that we have saved enough money over the years in tax-sheltered retirement accounts to live “in style”.

Unfortunately, this is not the case for many retiring Boomers.

Millenials (the children of the Boomers) are now having to make difficult trade-off decisions. This generation must make the difficult choice between caring for their parents and paying for the needs of their children. Not to mention, saving for their retirement and paying for their own needs. 

This is why it is important for Millenials to be aware of the many options out there. Options are just avenues to research so that they can make the right decision for their family. 

The reverse mortgage has received a lot of negative press in the past. This is because the process and option have not been sufficiently explained. I am not here to tell you whether this option is right for you and your family. I am just here explaining what a reverse mortgage is and how it could be an option.

This post will explain the reverse mortgage in greater depth, but a want to provide a quick summary here.

When would you use a reverse mortgage? When you have lots of equity in your home, want to continue to live in the home, and need additional fixed income. Please read this entire article, because there are stipulations to reverse mortgages.

Reverse Mortgage: Searching for Other Options

Reverse mortgages have been shrouded with controversy due to some confusion about how they work.  I would like to clear up some of that confusion and present it as an option for creating additional liquidity for retiring Boomers.

A reverse mortgage is a financial product for homeowners who are 62 or older and have accumulated equity in their home.

This home equity usually represents a substantial portion of an individual’s net worth. As you reach retirement age, you may need to tap into this wealth to supplement your fixed income.

Almost all reverse mortgages today are originated as Home Equity Conversion Mortgages (HECM).  The HECM is a program that is backed by the Federal Housing Administration (FHA). This means that these loans are guaranteed by the federal government.

How does a Reverse Mortgage Work: The Basics

A reverse mortgage is like selling your home to a bank.  First, the bank makes monthly payments to the owner of the home. Second, the owner must continue to use the property as a primary residence for the life of the loan.

The money you get is usually tax-free. As a general rule, you do not have to pay back the money for as long as you live in the home.

When you die, sell your home, or move out, you, your spouse, or your estate will have to repay the loan. Oftentimes, this means selling the home to get money to repay the loan.

Neither you nor your family must pay more than the sales price of the home (the appraised value) upon the owner moving out or passing away. This is because the HECM reverse mortgage is insured by the FHA. In short, the FHA’s insurance will pay for any shortfall.

If the heirs want to keep the home when the owner passes away they must pay off the loan. This is also the case if the owner moves out permanently (no longer uses the home as a primary residence). 

Remember that the owners took out a loan and received monthly payments from the bank. This means that the bank was slowly purchasing the home from them over time.

If the loan balance is more than your home is worth, the heirs will only have to pay 95 percent of the current appraised value of the property. Remember, the FHA’s insurance will cover the rest.

If the loan balance is less than the value of your home, they will only have to pay the loan balance.

Interested in Knowing More About a Reverse Mortgage?

Since this product usually requires that the home gets sold at the end of the term (when the owner passes away or moves out), the government has made it mandatory that a perspective borrower meets with a HUD approved counselor before obtaining a reverse mortgage.

This meeting is set up to determine if the product is suitable for the owner’s needs. The counseling session helps them and their heirs understand how the loan works.

As with any loan, all prospective borrowers must also undergo a financial assessment to qualify.

This assessment makes sure that the borrower can pay to keep the house afloat. This means that they can cover the following expenses: 

  • Property taxes
  • Homeowner’s insurance
  • Basic home maintenance
  • Home Owner’s Association (HOA) fees (if applicable).

You can apply for a reverse mortgage if:

  • The borrower must be 62 years of age or older
  • You own your home and use it as your primary residence
  • The house is a single family, multi-family (up to 4 units), an approved condominium, or manufactured home
  • You own your own home free and clear or only have a small amount left to pay on the existing mortgage
  • The home is in good condition prior to taking out the loan

 

An Example of How It Works:

Home equity is the difference between what your home is worth, its appraised value, and any debt that you owe from mortgages against the home. Unless you purchased the home outright with cash, you most likely have a first or even a second loan on the property.

When you own a home with a conventional mortgage, you gain equity over time as you pay down the loan. When you first start paying the loan, most of the monthly payment goes toward the interest. Over time you begin to pay more of the principal off and less of the monthly payment goes toward the interest.

Let’s say, for example, that you own a home worth $400,000 in today’s real estate market, and you only owe $100,000, because you have paid down the rest over the years that you have owned the property. This means that you have $300,000 in equity.

The amount you would receive from the bank each month is based off an equation that includes a few simple items. Click this link to use a free online reverse mortgage estimator.

Be careful:

There are non-FHA insured reverse mortgage loans that may have very different loan terms. So if you are considering a non FHA backed loan, make sure you understand the contract fully!!

Hopefully, I was able to dispel some of the myths about reverse mortgages, while providing a valuable option to increase your/your parent’s liquidity.

Many people ask whether a particular investment option is the “Best”, and my reply is that there isn’t one “best investment option for everyone”. Every individual has a unique financial situation and needs to decide what is the best option for them.

Have any questions? Post a comment!

 

Photo credits:

Couple on bench

 

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Lynzee Lai

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