According to the Bureau of Labor Statistics, there is no inflation in today’s economy. Social Security COLA increases, which are tied to inflation, have been held to a mere 1.5%. However, grocery shoppers and those people driving gas-consuming automobiles have seen the prices of food and energy increase dramatically over the past three years. For working families, this translates into serious belt-tightening in the area of disposable spending such as entertainment and dining out. For senior citizens and others on fixed incomes, this results in lowered living standards and induces the fear of running out of money during one’s lifetime..
Even seniors who have accumulated a healthy portfolio of stocks, bonds and savings are feeling an economic pinch. The stock market crash of 2008 that was triggered by the meltdown in the financial sector have served to rock what was once a plump, dividend-paying portfolio that either supplemented or replaced Social Security as the primary source of income. For example, one of the bluest of blue-chip stocks, Bank of America, cut its quarterly dividend from 60 cents per share to 1 cent per share after accepting TARP funds. Interest yields from CDs and government-issued bonds went from 5% per year to less than 1% per year. Seniors depending on dividend and interest income to pay for housing, purchase groceries or cover utility bills had those incomes cut by 80%.. Because these same people owned assets, they were also outside the bounds of traditional “safety net” social welfare programs. This combination of economic cataclysms has made the reverse mortgage look like a very inviting method for increasing cash flow.
A reverse mortgage is a collateralized loan that is available to homeowners 62 years or older that allows the person to borrow against the value of their primary residence and receive either a monthly annuity or a lump-sum payment. As long as the borrower stays in his or her home, the loan does not have to be paid back. Once the home is sold, the debt plus interest is repaid to the lender, and any remaining value goes to the seller. The income from a reverse mortgage is tax free, does not affect Social Security, and there are no restrictions on how the income is used. A reverse mortgage offers seniors supplemental income that can help maintain a good quality of life when other sources of income have failed.
There are no income restrictions on applying for a reverse mortgage. Although it is possible to apply for a reverse mortgage at age 62, lenders index the loan amount against the applicant’s age. The younger the borrower, the less they will be allowed to borrow. A borrower must also carry property insurance, property taxes must be paid up to date and the residence be maintained adequately. A borrower also cannot have any Federal liens on his or her income, such as for unpaid income tax. A low prevailing interest rate works to the borrower’s favor because a lender is likely to approve a higher loan amount.
Most reverse mortgages are backed by the agency for Housing and Urban Development (HUD). This means that a home or condominium must be HUD-eligible in order to qualify for a reverse mortgage. HUD also requires that borrowers attend a counseling session in order to ensure they fully understand the program, the costs involved to apply and the potential consequences of having a reverse mortgage.
There are a number of fees involved in applying for a reverse mortgage. These include an up-front fee known as a mortgage insurance premium (MIP). The MIP insures the lender against the risks of the loan, and can be as high as 2% of the home’s value. In addition, there are loan origination fees, loan servicing fees and third party fees for the appraisal, title search, property survey, inspections and credit checks. HUD offers a SAVER reverse mortgage that has much lower initial fees but also reduces the amount of money that can be borrowed. Borrowers who are already having a hard time making ends meet may not have the funds available to pay all of the fees due at closing and if fees are taken out of the borrowed amount, will find the amount they receive is substantially lower than they expected.
Once the loan is approved, the payout can be received either as a lump sum, as an annuity with equal monthly payments or as a line of credit in which installments are paid out at the time of a borrower’s choosing. Even though advertising suggests otherwise, payments from a reverse mortgage don’t offer carte blanche for reckless spending. They should be used to pay off unsecured debt such as credit card balances, medical expenses not covered by insurance or used to create or maintain an emergency fund for home repairs and maintenance. Funding a luxury cruise or gambling junket to Las Vegas with money borrowed against a home is foolish and this kind of spending is likely to encumber the homeowner’s or heirs with an overleveraged asset that must be sold within the 6 month time frame allowed under the contract.
A reverse mortgage may be a good fit for the senior who is house rich and cash poor, but he or she should consider other options before using a home as loan collateral. Selling the home outright and downsizing to a more affordable property or taking on a part-time job may be more constructive ways for healthy seniors to increase cash flow and meet spending needs.