Should You Use a Reverse Mortgage for Real Estate Investing?
A retirement plan that lenders have been pitching in the past 10 or so years is the reverse mortgage. Despite almost everyone being aware of the term, most people understand very little about this concept. Thanks to a brilliant marketer somewhere, the term “reverse mortgage”, has become popular. Known officially as a Home Equity Conversion Mortgage (HECM), these mortgages really got people’s attention. The concept of a reverse mortgage helped people visualize a paid off house that suddenly becomes a bank account for their retirement years. Since then, the reverse mortgage option has been packaged as a life saver for property owners who are reaching their golden years.
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Types of Reverse Mortgage Options
We were asked by a subscriber to shed some light on reverse mortgages. They especially wanted to understand reverse mortgages as a strategy for real estate investing. A reverse mortgage is basically a method to borrow equity back from your home without having to “pay it back.”
There are three different types of reverse mortgage options, all with various amounts of flexibility for your situation. They are Lump Sum, Monthly Payments, and Line of Credit.
Lump Sum – Your money is received in one lump sum payout at the time of closing.
Monthly Payments – With this, you will receive a payment from your lender each month. You must continue living in your home and meet all loan requirements.
Line of Credit – Draw from your loan whenever you choose. You will be charged interest on whatever you withdraw.
This article does a great job at comparing all three (Should You Take Out a Line of Credit, Lump Sum, or Monthly Payment with Your Reverse Mortgage?).
What Happens to My Home When I Die?
You may have realized that for some of these reverse mortgage options, lump sum especially, you may not be leaving your home to your heirs. If you think you are going to die soon, there may be more remaining of the reverse mortgage money to pass on. However, if you didn’t do a reverse mortgage, your heirs could sell your house when you pass and receive the proceeds from the sale. Before going too far, have a discussion with your children or next of kin. Make sure they understand the decision you are making to pull equity out if leaving an inheritance is a priority for you.
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The Details when Buying a Property Back
Let’s go into a little more detail on how your heirs could buy the property back. Lenders allow you to pick the lesser of the two options.
- Pay the outstanding balance of the mortgage off. Interest accrues on the money you are borrowing. If you die next year, your heir would pay almost the same amount you borrowed. In 20 years, the interest rate, around 4.92% according to ReverseMortgageAlert, will really increase the amount you’ll have to pay later. If the housing market has appreciated substantially, your heirs may be better off paying the mortgage balance.
- Pay 95% of the appraised value of the property. If the housing market does poorly and the home decreases in value, you could pick it back up for much less than the mortgage balance. This is obviously a very good decision in this case.
In summary, once all that interest adds up, or if the house appreciates a lot, it will cost much more to re-obtain the property. If that is the case, it’s much less likely your child will be able to afford to buy the house back. It’s also important to note that your age is going to make a big difference on the reverse mortgage deal you get. The older you are, the less cash you will receive up front. Similar to how a life insurance policy works, the mortgage company will lose money if you die sooner than the statistical average. Conversely, they make money if you live longer than the average.
Reverse Mortgage Obligations
Before considering a reverse mortgage, remember that you still have to fulfill these obligations:
- You must be at least 62 years old.
- The existing mortgage, if any, must be paid off first.
- Occupancy – The home MUST be your primary residence. As mentioned earlier, don’t try to do this with an investment property.
- Maintain property costs – Have the ability to pay your taxes, insurance, and other fees such as Homeowners Association (HOA) fees.
- Property condition – Just as you have to keep up on your required property costs, you have to keep the property in good shape. Since the lender may end up getting your house (see #5), they want that house clean and valuable. Before you get your reverse mortgage, an appraiser will come by and inspect the property. If he/she finds a significant problem with your home, you will have to hire a contractor to fix the problem. Afterward, the appraiser will come by and check your property to ensure repairs are done.
- Rights to own the property – The lender wants rights to the property after you pass away, or, they will either take 95% of the current appraised value or the mortgage balance, whichever is lesser. Check with your lender to get more details on this requirement.
What about Using a Reverse Mortgage for Real Estate Investing?
Wait a minute…you wanted to do a reverse mortgage for real estate investing. You wanted to borrow “HECM style” against a paid off investment property. That is why you are reading this article. Unfortunately, you can’t. The property used as collateral for your reverse mortgage has to be owner-occupied.
Should You Use a Reverse Mortgage for Real Estate Investing? Find out the details... Click To Tweet Now that we have that covered, let’s assume you want to take a reverse mortgage out on your primary residence to invest in real estate. Should you do that or not? This really is going to be a numbers game with the cost of borrowing money. Just as you would run the numbers on bank financing for a potential rental, you need to think of reverse mortgages as the same.
Closing Costs with a Reverse Mortgage
One concern with reverse mortgages is that the closing costs are high. Check out this Reverse Mortgage Calculator to run a hypothetical (or actual) scenario on a property. This calculator gives you an estimate of how much money you would get in a lump sum or a line of credit, depending on the option you choose. How much money you get is dependent upon your age, the interest rate of the loan, and the value of your home. This dollar amount is known as the initial principal limit.
The initial principal limit is the amount of funds that you’re able to receive from a reverse mortgage before closing costs. The rule of thumb is that you can take out up to 60% of this “initial principal limit” in the first year of the loan, according to consumerfinance.gov. Make sure to talk to a lender to get exact details, depending on your situation.
As with any investment you make, run the numbers (you can use our free tool), do your due diligence, and see if your financial situation is really going to improve or not. The closing costs and equity you lose in your home may really knock your net worth down compared to the benefit you’ll get out of the rental property.
Do You Need ALL of Your Equity?
Reverse mortgages are typically are for people who want all the equity out and don’t care about passing the house on to their kids or next of kin. If you just want “some” of the money for an investment, consider a Home Equity Line of Credit (HELOC) or even a standard Home Equity Loan. Want to know the difference? Check the video and blog from BankRate below.
Are You Truly Out of Options?
Reverse mortgages have actually been around for quite a while. However, you stopped by AssetRover because you want to do something smart with your money! Likely, you are going to invest that money into real estate to get passive income, tax benefits, and a physical investment that you can pass to your children when you leave this world.
Is it a good idea to use a Reverse Mortgage for investment property cash? Click To Tweet You might have already tried the bank route via a traditional mortgage, HELOC, and Home Equity Loan and things just didn’t work out. They see your financial situation or credit situation and don’t see how you are going to pay that monthly fee. Reverse mortgages have fairly minimum requirements since they get your home if things go sour.
There Are Many Ways to Pull Equity Out of Your Property
In conclusion, no matter which alternative you look at, you have a physical piece of real estate that has equity in it. Your home is likely worth a substantial amount of money if you financed the property decades ago. A bank may agree to put a lien on your property again. Keep in mind, a lien does need to be paid off and with that, you will have a house payment again.
Sometimes a solution to an immediate problem is attractive, but in the long run, it may be detrimental to your financial success. A reverse mortgage could be a great way to get extra money to help you enjoy your life and still keep your house. If real estate investing is your interest, you may be better off looking at more traditional methods rather than a reverse mortgage for investment cash. Whatever you do, look at the long-term consequences of your decisions.
Please remember, reverse mortgages, lines of credit, and other financing can be complex. Decisions like these, usually life changing MAJOR decisions should never be made based on reading one blog post on the internet. PLEASE consult with your financial advisor, lender, attorney, and other trusted members of your network to make sure your decisions really meet your financial and life goals! You can also talk to a reverse mortgage counselor. HUD-approved housing counselors can be found at HUD’s counselor search page or calling HUD’s housing counselor referral line (1-800-569-4287).
The AssetRover Team
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