If you’re like most of us, you probably pay to live somewhere. You either rent a place and pay by the month, or you “own” a place and make monthly mortgage payments. You might own your home free and clear, but even then you’ve got a financial burden—your money is tied up in your house. You can’t spend a house on medical bills or college tuition or groceries. It’s still worth as much or more as the money you but into it—hopefully—but you can’t use it for anything. A home is an investment rather than an expense.
This applies to all homeowners. If you’ve ever made even one payment toward a home, you have, in a sense, invested into that property. Your money has been converted into a form other than cash, and this alternate form—real estate—allows your money to work for you, to gain or lose value with the market. It’s like putting money into a savings account. Just like that.
Except, again, you can’t just take the money and use it when you need to. This creates a problem for homeowners who have diligently invested money into their homes by making mortgage payments for decades but need to see immediate financial returns from that investment. Typically, there are two ways to access the money that you’ve put into a house. You can sell the house and keep whatever money is left after paying back the mortgage with the sale proceeds, or you can take out a loan against your house in the form of a home equity line of credit (HELOC) and pay yourself back over time.
Sometimes, however, neither of these options is realistic. In the first case, you may get a nice chunk of change from the sale of your house, but now you have no house. Problem. In the second case, you’re just taking out a loan. You’ve got to start paying it back immediately, so it’s really not like accessing the equity at all. It’s like an equity yo-yo—you get some money, but you have to find a way to put it right back. Neither of these options works if you’re trying to live off the equity of your house and live in the house itself while you’re at it.
There’s a third option, however, that allows for this. It’s not well-known yet, but it’s becoming more and more popular as middle-class adults reach retirement age. This third option is called a reverse mortgage, and yes, it’s exactly what it sounds like—your mortgage payments start flowing in reverse, returning the money to your pocket.
It’s designed for seniors and retirement-age homeowners, individuals over the age of 62 who want to gain spendable income by accessing their home equity but don’t want to move out of their homes. Essentially, a bank writes up a reverse mortgage equal to the amount of the value of the house, and makes either one lump-sum payment to the homeowner for that amount or makes arranged payments on a monthly basis until the full value of the house has been paid out. It’s like the bank is buying the house and making mortgage payments on it, except that those payments go to you. It’s a mortgage in reverse.
If the bank is “buying the house,” does that mean that the bank owns the property? No. The original owner continues living in the house as though nothing has changed. His or her name stays on the deed. And the reverse mortgage payments keep coming in as income for the homeowner until the full value of the house is reached. At that point, you may expect that the owner would be forced to leave the property. This is not the case. The owner goes on living in the house until the day he or she dies. Nothing has changed, except that there is no longer any equity in the property waiting to be accessed. That value has been drained.
This is where some problems can arise. As mentioned, the owner can continue living in the house until he or she passes away, whether the reverse mortgage is still active or not. This is because the bank is not so much “buying the property” as “providing a very secured loan to the owner of said property in monthly installments.” But a loan always has to be paid back at some point, and this is the part that people tend to forget. There are three ways that a reverse mortgage can turn out.
The owner lives in the house until he or she passes away. At this time, the home and the reverse mortgage debt pass on to the owner’s heirs. The heirs can either sell the home to pay back the reverse mortgage or refinance and pay the reverse mortgage off themselves if they want to keep the house. If the owner has no heirs, the bank will sell the home and regain the amount of the reverse mortgage. In any case, whatever excess equity is left in the house goes to the owner’s heirs.
The owner decides to sell the house and move somewhere else. This can occur at any point during the reverse mortgage or after the equity has run out. Either way, the reverse mortgage ends when the house is sold. The proceeds from the sale go directly to the bank to pay back the reverse mortgage. Whatever money is left after that belongs to the owner. If the reverse mortgage has run out and the owner is still alive and decides to sell, he or she will keep none of the money from the sale, as the entire value of the house will have been drained through the reverse mortgage. If, however, the house has increased in value since the point when the reverse mortgage ended and this value increase is reflected in the sale price, the extra money goes to the owner. But this will likely be only a small amount of cash—not remotely enough to purchase a new home, typically. Once you’ve taken on a reverse mortgage, it’s best to stay in the house for good.
The owner “moves out” of the house for more than twelve months. Because the purpose of a reverse mortgage is to allow seniors and retirees to access their home equity in the form of income while still having a place to live, banks don’t like it when said retiree decides to live somewhere else and still draw income from his or her home. That’s kind of just taking advantage of the benefits the bank is allowing you. Thus, the twelve month rule—if the owner of the house moves somewhere else for longer than twelve months and doesn’t sell the house, the reverse mortgage stops and the owner is required to begin paying back the equity. In this case, the income provided through the reverse mortgage is treated just like a loan. You don’t want to deal with this.
In summary, a reverse mortgage is good for two things—allowing homeowners access to their home equity in the form of income and keeping them firmly rooted in their homes. But it does have its downsides, especially in the extreme long-run. Take it on a case-by-case basis. Either way, expect to see more of these in the near future as higher numbers of working adults reach retirement age.
Photo: James Thompson
 By The Weakonomist |
The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. Also keep in mind that nothing I say can be construed as financial advice. |
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Said,
This may be a dumb question, but is the reverse mortgage option only available on a house that’s been paid for? What if you still have a regular mortgage? Could you still get a reverse mortgage with a difference in your favor, if say your home value has gone up since the original mortgage was written?