People ask me the question, are reverse mortgages expensive? I typically reply by asking the question, “compared to what”?
Everything has a cost, and a reverse mortgage is no exception. There are both up-front costs to getting a reverse mortgage plus there is ongoing mortgage interest and mortgage insurance (there is no mortgage insurance on the non-FHA reverse mortgages). So how do these costs compare with any other type of mortgage or home equity line of credit? There are both upfront costs and ongoing interest for any of these types of loan programs. The biggest difference is that you pay the interest monthly on a traditional mortgage, so the costs are spread out over a longer period which ultimately makes it seem like traditional mortgages are less expensive. However, have you ever added up the amount of interest you pay each month and multiplied it by 12 months – and then 10, 20 or over the course of 30 years? Yup, the costs for a traditional mortgage can be quite high but because they are spread out over an extended period it does not feel as expensive.
In most cases, the upfront fees from a reverse mortgage can be financed into the mortgage so the homeowner does not have to use any cash out pocket. If a homeowner rolls the upfront costs into the reverse mortgage and they never make a mortgage payment for as long as they live in the home, and they live in the home for the rest of their life…they would never pay a penny to get the reverse mortgage. They will use some of the equity to cover the costs, but they are not using their cash which is far more valuable. In this case,
I would say the reverse mortgage is quite possibly the cheapest loan available.
You may argue that by using some of their equity to cover the fees, it costs them more equity than it would have cost them in cash. That might very well be true, but home equity is illiquid while cash is king and if they plan to live in the home for the rest of their life, their equity is unusable and worth far less than the value of having cash on hand. When the homeowner either passes away or permanently leaves the home, the estate will inherit the home and will decide if they want to keep the home and pay off the reverse mortgage or sell the home and pay off the reverse mortgage. It is certainly possible that the heirs may receive less equity, but it does not cost the homeowner any cash out of pocket in this case.
Furthermore, one could argue that the upfront costs can be recovered through home appreciation. The average home appreciation rate in the U.S. is around 4% historically. If you consider a $600,000 home, appreciating at 4% per year on average, that is around $24,000 of home appreciation in one year. If the upfront costs for a reverse mortgage are around $21,000, and the home appreciates $24,000, I would argue that the breakeven for the upfront costs is under one year to recover the costs based on a 4% home appreciation rate.
Lastly, I go back to my initial question, compared to what? Meaning, what are the other options you are considering? Are you thinking of selling your home instead to get access to your home equity? If that is the case, you must also consider the costs of selling your home. There are not only costs for Realtors but there could also be capital gains taxes that you must pay when you sell your home depending on your cost basis. Additionally, what is the cost to purchase a new home or to rent? Renting can be even more expensive costing you even more of your equity, and be riskier due to rising rents.
In the end, the costs of a reverse mortgage might be higher than a traditional mortgage. Let’s consider an example: if you have a $300,000 mortgage at 5%, you are paying around $15,000 in interest in the first year alone. With a traditional mortgage, you MUST pay your lender every single month both principal and interest. The interest is an ongoing cost that must be paid every month until the loan is paid off. Over the 30-year term, on a $300,000 mortgage, you will pay around $137,000 in interest over 10 years and around $280,000 of interest in 30 years. So do you think a 30-year fixed rate mortgage is cheaper than a reverse mortgage with no monthly payments?
Footnote: Please note that every situation is different, and you should speak to a reverse mortgage specialist about your specific situation. The reverse mortgage does not require you to make any mortgage payments as long as you live in the home, but you are still required to pay the property taxes, home insurance, HOA dues and home maintenance.
By Gabe Bodner. Gabe is a Retirement Mortgage Planner in Boulder. Gabe utilizes the latest research from the top researchers to assist his clients to Live for Today and Plan for Tomorrow. To reach Gabe, call 720.600.4870, e-mail [email protected] or visit reversemortgagesco.com.