A reverse mortgage is a useful tool for helping senior citizens remain in their homes and maintain their lifestyle.
A reverse mortgage is a ripoff, a scam. Don’t fall for it or you might lose your house!
So which is it, a blessing or a trap? As with most financial products, the answer is, “It depends.” For some clients, it is just the opportunity they need for financial stability, but for others, it can be a danger. No one solution is right for everyone, as we all know.
Most of us in the financial planning field are familiar with the basics of a reverse mortgage. It is a means by which older homeowners (62 or over) can make use of the equity in their home without having to make payments on a loan. The amount a person can access depends on the value of the home, the age of the homeowner and interest rates. The money can be taken as a lump sum, monthly payments, or a line of credit. Nothing needs to be paid back until the home ceases to be the primary residence, either due to death or to the homeowner moving, perhaps to a nursing home.
Along with the age restriction, there are a few other conditions. Besides a single family home, a 2-4 unit building also qualifies, as long as the owner occupies one of the units. The home generally must be owned free and clear, although if there is a low mortgage balance it can be paid off with proceeds from the reverse mortgage. A financial assessment should be done to assure that the homeowner will have the means to keep paying property taxes, insurance, and maintenance.
Most current reverse mortgages are FHA-insured Home Equity Conversion Mortgages (HECM). There is a maximum amount a person can borrow under this program, currently $625,500. The owner of a higher-valued home might consider a proprietary reverse mortgage through a private lender. These are not subject to the HECM loan limits.
Under certain circumstances, a reverse mortgage can be the perfect instrument to address a senior’s needs. A lump sum can be used to make necessary home repairs or adaptations for an elder. A monthly stream of income might be the difference between an active or restricted lifestyle. Perhaps a line of credit can be tapped for a special vacation or a new vehicle.
A reverse mortgage is not the solution for everyone, however. In some cases, the homeowner might be better off downsizing, or moving to an assisted living facility. Some people might take a lump sum, only to squander it and be left with no equity and no cash. Unexpected expenses may deplete resources needed to pay property taxes, insurance, etc. And there may be no value left for heirs. If the heirs don’t have the means to pay back the mortgage themselves, they will have to sell the home. Fortunately, there is usually a “non-recourse” clause in the agreement so that if the value of the home is less than what is owed, the heirs don’t have to make up the difference.
Reverse mortgages come with significant fees and closing costs, so it’s worthwhile to shop around. However, the client must beware of salespeople who try to pressure them into a hurried agreement or sell them other products to invest the proceeds. There are always shady operators out there, and the best course of action for a client is to consult with a financial planner and consider all options before making a decision.
Housing is usually a significant part of a budget. The advantages of homeownership are security, privacy, peace of mind and pride of ownership. Some people also feel that a home is a better environment for raising children than an apartment.
Home ownership also has tax advantages because mortgage interest and property taxes paid on a home may be deductible expenses on the federal income tax return. In some states, homestead laws also protect a person’s home from certain creditors. A home can be a good inflation hedge because houses often appreciate as much as or more than inflation.
However, a home should be considered primarily as a place to live, rather than an investment asset. The big investment required in a house is often the most significant disadvantage of home ownership. Moreover, the investment is relatively illiquid. Another possible disadvantage of home ownership is that home values can decrease, as many homeowners discovered when the housing bubble burst several years ago. The time and money required to maintain a home can also be a disadvantage.
Renting may be advantageous if a person plans to move from a community soon. Renting can be less expensive than paying for closing costs, real estate agents’ fees and maintenance on a home. The problems and delays associated with selling a home can also be avoided. But if a person will remain in a community for some time, homeownership should be considered because the mortgage payment will remain fixed, while rent will generally increase with time.
The 5 Most Important Factors to Consider
In deciding whether to buy or to rent, a person should perform a financial analysis of the following factors:
1. Amount of the monthly rent versus the monthly mortgage payment.
2. Property taxes, the amount of mortgage interest and the individual’s tax bracket because taxes and mortgage interest are deductible.
3. Cost of insurance and maintenance.
4. Lost income on the money used as a down payment.
5. The increase in equity on a home, including reduction of the mortgage principal amount and the home’s appreciation.
Advice for Renting
For those who choose to rent, it is important to choose the rental unit with careful consideration and inspection. It can also be a challenge to objectively compare multiple rentals to each other. That’s especially true for students who may be renting for the first time.
To help with this process, we created a renter’s checklist. The checklist covers all the important elements of the renting process, starting with reviewing the terms of the lease. It also has a detailed section on inspecting an apartment, as well as factors to consider for the surrounding neighborhood. You can download and print this free checklist: INTRO Guide Appendix A- Sample Renter’s Checklist
A conventional mortgage is usually a fixed mortgage, which means the interest rate and amount of each monthly payment are fixed. Conventional mortgages are traditionally not insured or guaranteed by any agency, although now private mortgage insurance is available to insure losses in the event of a default.
The Basics of FHA and VA Mortgages
An FHA mortgage is a loan given by an approved lending institution, and the loan is insured by the Federal Housing Administration. The borrower pays a fee for the FHA loan insurance, but this fee can be amortized over the life of the loan. In the event of default, the FHA will pay the lender for any losses.
VA mortgages are guaranteed by the Veterans Administration. Only honorably discharged Veterans of the U.S. armed forces are eligible for these loans. The VA, like the FHA, sets the interest rates, qualification standards, and down payments required for their mortgage loans. While interest rates for VA and FHA loans are set by these agencies, rates for conventional loans are set by the lending institutions and depend upon money market supply and demand.
More Details About FHA and VA Mortgages
FHA and VA mortgages may be assumable, which means a buyer can take over the existing mortgage and make the monthly mortgage payments to the lending institution without qualifying for a new mortgage. The lender also cannot increase the interest rate or require refinancing of these loans. Most other mortgages contain due-on-sale clauses which require payment of the mortgage balance upon the sale of the property. These clauses force refinancing of the mortgage loan whenever a property is sold.
Are There Advantages to An Assumable Mortgage?
An assumable mortgage can be advantageous to the buyer because the buyer is relieved of qualifying for the mortgage, and the interest rate on the existing mortgage may be below the current market rate. In addition, the buyer can avoid paying several costs that are associated with obtaining a mortgage loan. For example, to obtain most mortgage loans, a borrower must pay an origination fee to the lender for arranging the loan.
The borrower may also pay points, which are essentially a way to increase the lender’s return on the loan in the first year while offering the borrower a slightly lower interest rate. A point is one percent of the mortgage loan amount. On a $100,000 mortgage, one point is $1,000. A borrower must also pay closing costs, which may include title insurance, attorney’s fees, recording fees, survey and appraisal fees, credit reports, and insurance and tax reserves.
In addition to avoiding payment of the origination fee and points, an individual assuming a mortgage can avoid some of the other closing costs associated with purchasing real estate. Note that the assumption of an existing mortgage may not make sense where the interest rate on the existing mortgage is above current market rates or where the existing mortgage balance is relatively small.
Successful budgeting can help an individual anticipate future financial needs and prevent financial problems like those that arise from taking on too many financial obligations and incurring too much debt. A budget is useful in helping an individual to achieve financial goals and can also be a tool for increasing net worth or for achieving financial security.
The Basics of Budgeting
The stages of the budgeting process are estimating income, estimating spending and planning for savings. Income can be estimated using gross income or net income after deduction of items regularly withheld from a paycheck. For a client on a salary or receiving a regular wage, estimating income probably won’t present much of a problem. But for a self-employed person, the fluctuation may require a low estimate of income for budgeting purposes.
Estimating spending is complicated somewhat by certain large expenditures that arise annually or semiannually. Regular deductions or contributions to a savings account may be required to pay for items such as an annual insurance premium or annual assessment of real estate taxes. In budgeting expenditures, some payments like rent or the mortgage are not subject to much immediate reduction. Other items like clothing, recreation and entertainment may be readily controlled. Additionally, one must always take into account the effects of inflation.
Savings should be planned as part of the budget and not considered a residual that will simply materialize if expenditures are controlled. Conscious effort is required to save. Financial planners often recommend saving 5% to 10% of income annually. The exact amount of savings needed to reach goals will be determined as part of the planning process. Arrangements can be made with a bank to transfer a specific amount each month from a checking to a savings account.
9 Rules for Budgets
The following rules can be helpful in preparing budgets:
1. Be reasonable in establishing goals.
2. Budget for fixed expenses like a mortgage payment or rent first.
3. Make saving a priority.
4. Necessities like food, clothing and transportation may be variable expenses but a high priority.
5. Set aside money over many income periods to spread out payment for large annual expenses.
6. Large expenses are not necessarily the easiest to cut.
7. Develop priorities for general categories of expenses and don’t try to account for every penny.
8. Records should be kept of expenditures after the budget is established.
9. Use it to measure and understand actual versus planned results.
If the estimated expenditures and planned savings exceed income, the financial planner and client should review expenditures to see where the expenses can be reduced. The budget should balance. Moreover, the budget will work only if the estimates have been realistic.
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