Reverse mortgages, despite high upfront costs, have advantages over conventional mortgages
A "reverse mortgage" is designed to help you get equity out of your house - without having to sell it and move.
It pays you a monthly amount that you select (based on the options for which you qualify, such as your age). The amount paid is added to the mortgage every month along with applicable interest. Thus, unlike a regular mortgage, the balance owed goes up, not down.
The fact that the balance increases worries many people and discourages them from taking out reverse mortgages. But you are protected. You cannot be forced out of your house to pay off a reverse mortgage.
Your monthly payments will go on until you have collected all the money for which you signed up initially. Then they stop, but even then you will not be forced to pay off the mortgage. The balance is not due until you either sell your house or die.
The other big objection to reverse mortgages is that they involve unusually high upfront costs for most people. (In Massachusetts, Homeowner Options for Mass Elders (H.O.M.E.) provides low fee reverse mortgages for seniors with low incomes, but for others the regular fees apply.)
Up-front costs for a reverse mortgage including closing costs, fees and insurance, can range from $14,000 to $20,000 or more. You do not have to pay this when you get the mortgage. It is simply added to the balance.
Reverse mortgage vs. regular mortgage
If you need money for living expenses and you do not want to stay in your house, there are two ways to use the equity in your house to provide you with the cash you need. One is to get a regular mortgage and the other is a reverse mortgage.
Even if you do not have much income, if you have enough equity in your house, you may qualify for a regular mortgage. This may be the best option if you are going to need the money for less than five years. But if you plan to be in your house for more than five years, the reverse mortgage makes more sense, despite the upfront costs.
To illustrate this we compared a $100,000 regular mortgage to a reverse mortgage that would cap out at $100,000. We assumed that you would use them to provide $8,333 a year in spending money. Then we compared closing costs, interest costs and length of time the loan would provide payout.
In brief, the conventional loan looks better for up to five years. We assume a 30-year fixed interest rate loan at 6.5%, $3,000 in closing costs and that whatever balance you had not yet used at would be invested in a CD at 4.5%.
Over four years, you would have spent $22,805 in net interest (that is interest paid to bank minus interest on your CD's), and spent about $42,000. This compares fairly well to the reverse mortgage (we'll show those numbers next) but it quickly looks worse.
For one thing the money will run out after six years, and you will still owe the bank 24 years of payments at $632 a month. So you will have switched from extra spending money of $8,333 a year to a bill for almost $7,500 a year. Without some other source of income you would probably have to sell your house at that point.
Reverse mortgage looks better if you need money for more than four years.
If you had taken out a reverse mortgage instead of a regular mortgage with a $100,000 maximum, you would have started out with an estimated $14,000 in closing costs. Assuming an interest rate of 6.5% (same as for the conventional mortgage) the first year would see $8,333 in payments to you added to the balance and $1,452 in interest.
The balance owed rises by about $10,000 a year for the first few years, but the good news is that it does not get to $100,000 until the ninth year.
That is, the reverse mortgage will pay you $8,333 a year for almost nine years, at the end of which your total debt will be $100,000, not to be paid until you sell the house.
With the conventional mortgage you would chewed up the $100,000 in six years, and at the end of that time you would have to keep paying $652 a month.
All situations require individual evaluation.
The figures used here illustrate a general principle, which is that in the short term, a conventional mortgage may be the best way to take money out of your house, but once you get beyond five years, a reverse mortgage looks better, even with high upfront costs.
However, each situation is different. What works in general may not work for you. You should get good advice based on your specific facts. Reverse mortgages require that you get good advice and counseling before signing, but regular mortgages do not. Our advice is to get good advice in any case.
And make sure you discuss the situation in detail with your heirs. It is usually best to bring them into the situation up front.