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Borrowing From Your Home in Retirement

For most homeowners, particularly retired Americans who have paid off or nearly paid off their mortgage, their house is a major part of their financial picture. Unfortunately, for retired homeowners who may have limited sources of income, the equity in their house may seem to be one of the only potential sources of additional money for everyday living expenses and health care.

While borrowing against equity can help older homeowners, there also are potential pitfalls. "In particular, failure to repay a home loan according to its terms can lead to the loss of the home," cautioned Glenn Gimble, an FDIC senior policy analyst. Here are things to consider before borrowing from your home in retirement.

Before agreeing to a reverse mortgage, research the potential benefits as well as the risks and costs. A reverse mortgage is a way for seniors aged 62 years or older to borrow against a portion of the value of their home. Instead of making payments to a lender, the borrower receives payments or perhaps one lump sum payment, which is the "reverse" aspect of this type of mortgage loan.

While the amounts borrowed will eventually have to be repaid, with interest, repayment will not come out of the homeowners' pocket as long as they live in the house and keep up with other obligations (such as paying property taxes and insurance and maintaining the home). Instead, the loan, with interest, typically will be repaid when the borrower or his or her heirs sell the house.

The most popular reverse mortgage program is the Home Equity Conversion Mortgage (HECM) program, which is offered by the U.S. Department of Housing and Urban Development (HUD). The HECM program allows a homeowner to draw upon the equity in a home through either a fixed monthly payment to the homeowner, a line of credit, or a combination of the two options. To be eligible for an HECM, homeowners must be at least 62 years of age and own or nearly own a home that is their primary residence. There also are other requirements.

One criticism of the standard HECM is the up-front cost related to insurance on the loan. In response, in 2010 HUD introduced a second type of reverse mortgage, called an HECM Saver, which features considerably lower up-front costs for people borrowing a smaller loan amount than the standard HECM allows. Otherwise, the eligibility requirements are the same for both programs.

Do your research and pursue in-depth counseling before agreeing to any loan backed by your home. In fact, one of the requirements of both HECMs is that potential participants must first talk to a HUD-approved counselor. "The counselor should review, among other things, the implications of receiving a reverse mortgage, including repayment options, and alternatives to an HECM loan," explained Cassandra Duhaney, an FDIC senior policy analyst.

In addition to reverse mortgages, there are other types of loans for which a home is the collateral. Some, called second mortgages, are loans for a fixed amount of money, for a fixed amount of time, and at a fixed rate of interest. Others, known as home equity lines, offer revolving lines of credit from which the homeowner can borrow some money (often at a variable interest rate), repay it over time, and then borrow again. No matter what kind of home-based loan you consider, experts generally recommend talking to financial advisors and qualified housing counselors.

"The pros and cons of borrowing against a home in retirement depend on several factors, including a person's income, savings, and short- or long-term housing goals," said Gimble. "Determining whether a borrower can comfortably repay the loan according to its terms is a critically important question."

There are numerous other reasons to carefully research a reverse mortgage. For example, if you need to move into a retirement home, you will be required to either pay back the loan balance or sell your home. Also, interest charged on a reverse mortgage adds to the total loan balance, which may outstrip the equity in a home when it is sold, leaving few or no proceeds from the sale for the homeowner or heirs. In addition, be cautious if anyone approaches you about a major investment or purchase, especially something you previously didn't think you needed, and puts pressure on you to get a reverse mortgage to pay for it. These kinds of concerns explain why the most popular reverse mortgage programs require counseling to ensure that potential borrowers understand how reverse mortgages work.

Experts also generally say that homeowners who don't plan to stay in a home more than 5 years should explore alternatives to reverse mortgage loans. "HECMs and other reverse mortgage loans typically come with upfront costs and fees, making them less suitable for short-term borrowing," concluded Duhaney. "Home equity loans and lines of credit, which often come with few or no costs or fees, may be more economical and prudent if a borrower only needs limited funds and can qualify."