Using a reverse mortgage to pay off existing mortgage
Does your mortgage payment still consume a large chunk of your retirement income? If so, you may want to consider applying for a reverse mortgage to pay the remaining balance. This is by far the most popular use of the home equity conversion mortgage (HECM reverse mortgage) and more than 1M other seniors have this program for a reason.
You are not required to own your home free and clear before applying for an HECM reverse mortgage loan, but the property will need to meet qualifications (have sufficient equity available) to pay off any existing liens on your home.
This is because you are not allowed to have both a forward conventional mortgage loan and an HECM loan on the same property concurrently. The reverse mortgage was designed for seniors to use to pay the full balance on your conventional mortgage, thus having equity is a necessary to qualifying for this loan.
Some homeowners, in fact, apply for a reverse mortgage for the sole purpose of removing the principal and interest payment on their homes from their monthly budgets to save thousands every year.
In essence, what you are doing under this strategy is increasing the amount of money you owe on your home, but deferring the repayment of that debt until you pass away or move out of the property. Your overall mortgage debt increases, but you have more income available to spend on items other than housing.
For example, in one scenario a 65-year-old homeowner’s property is currently valued at $400,000, and he or she owes $75,000 on the mortgage. If the borrower just used the reverse mortgage proceeds to pay off the original mortgage, after ten years the reverse mortgage balance, including fees and interests, would be around $135,000.
So if you had to sell the home in 10 years either because of death or move, the proceeds remaining after the reverse mortgage was repaid could be $265,000, and that’s assuming the home didn’t appreciate in value during those ten years.
In the same scenario, the borrowers would owe close to $210,000 if they remained in the house for 20 years after obtaining the reverse mortgage.
So again, the choice is:
- Having less to pay in monthly expenses during this period by paying off the traditional mortgage, but owing a reverse mortgage lender a hefty sum once you pass away or move out of the home; or
- Maintaining the monthly payments on the first mortgage for as long as it takes to pay the balance in full but being able to pass along the property’s full value to your heirs without having to pay a reverse mortgage lender.
Reduced expenses AND increased income
Another option to consider is that the homeowner could obtain a reverse mortgage that would pay off the existing mortgage balance, plus provide additional monthly income. In the above example, the borrowers, even after paying off the remaining $75,000 mortgage balance, would have enough left over to generate between $600 and $700 a month in income.
If the borrower received $600 a month from the reverse mortgage, the total debt on the loan would equal about $225,000 over ten years and about $445,000 over 20 years.
The borrower could also pay off the mortgage and receive an additional lump sum of approximately $44,000, or have access to a line of credit.
The potential downsides
One of the downsides to this strategy is the upfront cost of obtaining the reverse mortgage. In the above example, the fees and closing costs would total about $10,000. This amount can be rolled into the reverse mortgage loan, so that it doesn’t have to be paid at closing, but it will nonetheless add to the overall amount owed to the lender.
Another consideration is that the debt you accumulate through the reverse mortgage will likely include mortgage insurance premium, which you will be charged for annually. Like interest amounts, mortgage insurance premium costs accrue over time on a reverse mortgage, and you pay it once the loan is called due and payable. The annual premium is 1.25 percent of the outstanding loan balance.
Also keep in mind that this approach will only eliminate the monthly principal and interest part of your mortgage payment. With a reverse mortgage, you still own the property and are therefore responsible for paying taxes and insurance. In fact, failing to keep up with those obligations could result in a default of the reverse mortgage loan.
Review an amortization schedule
To determine if it’s financially beneficial to use a reverse mortgage to repay your conventional loan, you should review an amortization schedule provided by a prospective lender.
Reverse mortgages use a negative amortization because the loan balance increases over time. That’s because you aren’t making monthly payments to make the loan balance smaller; the longer you have the reverse mortgage, the more money you’re borrowing and/or the more interest is accruing.
A reverse mortgage amortization schedule can help potential borrowers estimate how much they will eventually owe once the loan is due, which occurs when the homeowner(s) passes away or moves out of the home. At that point, the home is typically sold, and the proceeds are used to repay the loan.