You've probably seen the ads on TV touting the benefits of a reverse mortgage. They're a special type of loan exclusively for homeowners 62 or older that lets them convert part of their home equity into cash. There are no restrictions on how the cash can be used and the borrower doesn't have to repay the loan or make monthly payments on it unless the home is sold or vacated.[1]
Reverse mortgages have been a boon to retirees on a fixed income. Where previous generations of older Americans would have been reluctant to take money out of the home they'd spent a lifetime paying for, today's seniors are embracing the concept. According to a study by MetLife Mature Market Institute, about 35% of older Americans see their homes as source of collateral for a loan of this type.[2] In 2014 alone, Americans took out 49,194 reverse mortgages totaling $6.3 billion at an average interest rate of 3.15%.[3]
Requirements and Restrictions
Reverse mortgages sound great if you're a senior trying to get by on Social Security or somebody who was at or near retirement and saw her 401K tank in the last recession. But like all good things, reverse mortgages have restrictions. If you take out a reverse mortgage loan, you must remain current on your property taxes and any condo fees (if applicable), and you must have sufficient homeowners insurance coverage.
How Much Homeowners Coverage Must You Carry?
Just as with any other type of home loan, a reverse mortgage means your lender wants some type of collateral to protect the investment in the invent your home is damaged or destroyed by a fire or some other disaster. Since most of the value of a home typically is the value of the land it's sitting on, the total value of your homeowners insurance policy need not be equal to the appraised value of your home.
Standard homeowners policies are typically written for replace cost coverage, meaning the policy will pay to repair or replace damage with new materials of a similar type and quality, without deduction for depreciation. Generally, your reverse mortgage loan documents will require that you carry a homeowners policy equal to 100% of replacement cost of the property. If you have valuable personal property, you'll want to add additional coverage to replace those things if they're stolen, lost or damaged. You'll also want to be sure that you have a deductible you can afford in the event of a claim.
If you make improvements on your property after taking out the reverse mortgage, you will need to update your insurance policy to reflect their replacement value.
Depending on where your home is located, you may also be required to carry supplemental policies such as flood, earthquake or hurricane insurance too.
You can shop for and compare costs for homeowners insurance policies here.
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