MONEY MANAGEMENTFrom the Virginia Society of Certified Public Accountants - Presented by Dean Knepper, CPA, CFP®
REVERSE MORTGAGES: THE PROS AND CONS OF CASHING IN
(April 26, 2006) — A reverse mortgage can be a powerful tool for converting home equity into cash that can help you make ends meet. However, reverse mortgages also present some financial risk. The following information, provided by the Virginia Society of CPAs, presents the pros and cons of reverse mortgages to help you determine if this financial strategy is right for you.
How reverse mortgages work
Reverse mortgages work like traditional mortgages, only in reverse. Rather
than paying your lender each month, the lender pays you. These payments are
actually cash advances against the equity in your home.
The maximum amount that can be borrowed is usually based on the age of the homeowner, the appraised value of the home, and the current interest rate. Generally, the more equity you have in your home, the older you are, and the lower the interest rate, the more you can tap into it for cash. With most lenders, you may choose to receive your payment as a lump sum, in regular monthly payments, as a line of credit you can draw against when you need cash or some combination of these options.
You continue to own your home and are responsible for property taxes, operating expenses and maintenance. Because you make no payments on the loan, the balance owed increases each month as interest is applied and compounds.
To qualify for a reverse mortgage, you must be age 62 or older, and you must occupy the home as your principal residence. Your home must be owned free and clear or have a small outstanding mortgage balance that can be paid off with the reverse mortgage. Unlike a traditional mortgage, there are no income, employment or credit-qualifying requirements.
What about repayment?
With a reverse mortgage, repayment is due when you die, sell your home or no longer occupy it as your principal residence. At the time that payment is due, there is no requirement that the property be sold, only that the loan be repaid. This may be achieved through the sale of the home or through other resources.
Pros of Reverse Mortgages
The cash payments you receive are tax-free since they are loan proceeds and not income, and they generally do not affect Social Security or Medicare benefits.
There are no minimum income requirements to qualify and no credit checks. You
can use the money for any purpose. You may be able to create a cash flow stream
for the remainder of your life.
Cons of Reverse Mortgages
Reverse mortgages are complex. In fact, you must attend a counseling session
before applying for a reverse mortgage.
Your eligibility for state and federal government assistance programs such as Medicaid may be affected.
Reverse mortgages can have very high up-front closing costs. If you think you might move in a few years, a reverse mortgage may not be the best decision. They make the most sense for those who plan to stay in their homes permanently.
Reverse mortgages are relatively expensive. The interest is added to the loan balance each month, and the total interest you owe increases greatly over time as the interest compounds.
A reverse mortgage uses up the equity in your home, so it reduces what you have left to leave your heirs.
Consult with a CPA
Your home is likely to be your most valuable asset. Before you tap into the
equity in your home, consult with a CPA who can examine your financial situation
and help you determine if a reverse mortgage makes sense for you.
The Virginia Society of CPAs is the leading professional association dedicated to enhancing the success of all CPAs and their profession by communicating information and vision, promoting professionalism, and advocating members’ interests. Founded in 1909, the Society has nearly 8,000 members who work in public accounting, industry, government and education. This Money Management column and other financial news articles can be found in the Press Room on the VSCPA Web site at www.vscpa.com.
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