Back in 1987, when I first entered the finance business, it very quickly became evident to me that it is a whole lot easier to borrow money when you do NOT need the money than when you do.
If this concept is new to you, think of it this way. If you are unemployed and just need a few thousand dollars from a credit card to make it through until the new job kicks in, it’s much easier to get if you already have a credit card with the funds available. If you apply for a credit card while unemployed, odds are, you’ll be turned down.
This analogy isn’t an exact parallel to reverse mortgage, but it’s close enough that I think you’ll get the point. There are a lot of advantages to setting up a reverse mortgage as close to age 62 as you can, even if you’re still working, even if you don’t “need” it now. I only have space in this article for one, but before we get into why you’d want to do this, I want to take a moment to explain what a reverse mortgage is and how it works.
Most reverse mortgages originated are insured by the Federal Housing Administration (FHA) and are called Home Equity Conversion Mortgages (HECM). A HECM reverse mortgage allows homeowners, age 62 and above, to convert a portion of the value of the home into tax-free* money without having to sell the home, give up title or obligate them to a monthly mortgage payment.
FHA has a formula to determine the amount of money available to the homeowner from a reverse mortgage. It’s based on the age of the youngest spouse, the value of the home, and the interest rate. While this formula determines the amount of money available, the homeowner is not required to take all of the funds at once.
Homeowners can choose to receive funds from a reverse mortgage in a variety of ways:
- All in one lump sum (to pay off an existing mortgage for example)
- As a line of credit to be used at the homeowner’s leisure
- As a monthly payment to the homeowner
- Or any combination of the above
Reverse mortgages are for primary residences only. The homeowner must live in the home. The lender does not take title to the home, they simply have a lien against it, just like any other mortgage. Since the property stays in the homeowner’s name, it is still their obligation to keep current on their homeowner’s insurance and property taxes, as well as maintaining the home.
The homeowner is not required to make a mortgage payment, but they are still charged interest and mortgage insurance on the loan balance. These charges are added to the loan balance, so it increases over time. But these charges are only on the amount owed on the loan balance. There are no charges on any unused funds in the line of credit or monies set aside to pay monthly payments.
However, one of the benefits of the reverse mortgage is “payment flexibility”. You can make payments on the loan, but you don’t have to.
If you’re only 62 and you have an existing mortgage against your home, you can get a reverse mortgage to pay off this loan, but continue to make payments,
only now these payments are being applied to the reverse mortgage loan. If you retire at age 65, you might decide to discontinue the payment.
Or if money is tight one month and you can’t make a payment, no bill collector is going to call you. The choice is yours to make a payment or
Making payments on your reverse mortgage loan has three major benefits:
- It lowers the loan balance.
- It builds a higher LOC (more on this in part 2)
- It reduces ongoing interest and MIP charges.
Making payments may also maintain equity for a time when the borrower decides to sell or passes away and leaves the home to their heirs.
This is just one of the benefits of getting the reverse mortgage at an early age when you don’t need the money. In future posts, I’ll be discussing additional benefits of this strategy. Please stay tuned.
*Consult your tax advisor