Between the rising costs of living and medical care and limited Social Security benefits, many American seniors hit 60 years with limited income to sustain them through retirement. The need to fund their retirement draws them to the idea of taking out a reverse mortgage. What was traditionally viewed as a last-ditch source of cash for homeowners is now becoming a popular way to secure a comfortable retirement, but is tapping into your home’s equity a good idea?
Like any financial decision, you must assess your options for a reverse mortgage. This is a complicated financial product that carries significant risks and costs that must be taken into account. Read on to learn more about reverse mortgages, how they work, the advantages and disadvantages, who they are suited for, and their alternatives.
What Is a Reverse Mortgage?
A reverse mortgage is a special type of home loan that lets seniors who are 62 or older convert part of their home equity into cash without selling the home or paying additional monthly bills. You’re simply borrowing money using your home as security for the loan. You’ll receive monthly payments from your home’s value instead of paying down the mortgage loan.
Some of the eligibility requirements for a reverse mortgage include:
- You must be 62 years or older.
- You must occupy the home as your primary residence.
- You must attend counseling through the Department of Housing and Urban Development.
How Do Reverse Mortgages Work?
Your home has monetary value you can collect in cash when you sell it. However, a reverse mortgage lets you cash in on your home’s monetary value without selling it. A reverse mortgage lets you borrow money against the equity in your home—which is the difference between your home’s appraised value and your outstanding mortgage balance. The equity in your home increases as your mortgage balance goes down or the value of your property grows.
When you take out a traditional mortgage loan, you make monthly payments to the lender to buy the home over time. With a reverse mortgage, you receive a loan from your lender. A reverse mortgage takes a part of your home’s equity and converts it into cash payments to you—a type of tax-free advance payment on the equity in your home. And, similar to a traditional mortgage, you retain the title of your home.
Your lender charges interest on the money you receive. The interest on a reverse mortgage is usually compounded, so you’re technically charged for the principal and interest accrued each month. As a result, the outstanding balance on your loan increases over time.
Typically, you don’t have to repay the loan for as long as you’re in your home. When you move out, sell your home, or pass away, you, your eligible spouse, and/or your estate will repay the loan. At this time, the full loan balance will be due, or your home goes into default, which could lead to foreclosure.
In most cases, your primary residence must be sold to recoup the money needed to repay the loan. If you pass away while holding a reverse mortgage, your heirs should receive a notice from the lender to sell the home, buy the home, or turn the home over to the lender to repay the debt within 30 days. However, your lender may extend the timeline to a year to give the heirs time to sell the home or secure financing to buy the home. Luckily, reverse mortgages are non-recourse loans, so your lender can’t seize your assets to meet the outstanding balance if you default on the loan.
With a reverse mortgage, you retain the ownership of your home, so you’re responsible for property taxes, homeowners’ insurance, and keeping the property in good shape.
Thinking a reverse mortgage may be your ticket to a comfortable retirement? Here are the three types of reverse mortgages you can choose from:
- Home Equity Conversion Mortgage (HECM). The HECM is the most common type of reverse mortgage. HECMs are obtained through lenders approved by the Federal Housing Administration (FHA) and are backed by the US Department of Housing and Urban Development (HUD). You can use this type of reverse mortgage for any purpose.
- Single-Purpose Reverse Mortgage. This type of reverse mortgage is offered by local and state governments as well as non-profit organizations. Just as the name suggests, you can only use these mortgages for the purpose your lender specifies, say property taxes or home repairs. Single-purpose reverse mortgages are only available in some areas and may be reserved for homeowners with low to moderate income. These reverse mortgages are not federally insured.
- Proprietary Reverse Mortgage. Proprietary reverse mortgages are issued by private lenders and are mainly designed for borrowers with higher-value homes.
Pros and Cons of Reverse Mortgages
Before choosing a reverse mortgage, here are the pros and cons of reverse mortgages you must know.
Pros of Reverse Mortgages
- Regular income. Reverse mortgages let you receive regular income in your retirement years as long as the home is your primary residence.
- Deferred repayment. A reverse mortgage doesn’t just give you a defined cash amount, it also eliminates monthly mortgage payments to a lender. Better yet, you don’t need to repay your reverse mortgage loan until you move out, sell the house, or pass away.
- Tax-free proceeds. The funds you receive are not considered income, so they are not taxable.
- Choice of how to receive the funds. When you take out a reverse mortgage loan, you can choose a disbursement plan that aligns with your retirement goals. You can choose to receive the funds in a single lump sum or in small amounts over time. You can also have the funds set aside as a line of credit that grows over time.
- Non-recourse loans. FHA reverse mortgages are non-recourse, so you or your heirs can’t owe more than your property’s value. And no assets other than the home itself can be seized to pay off the mortgage balance.
Cons of Reverse Mortgages
- You could lose the home to foreclosure. You’re still responsible for paying property taxes, homeowners’ insurance, homeowners’ association fees, repair expenses, and other costs associated with home ownership. If you become delinquent at any point during the loan period, you could default on the reverse mortgage loan and lose your home.
- The home must be your principal residence. You can’t use a reverse mortgage for an investment or vacation home, and you must live inside the home for most of the year.
- There may be less for your heirs. Unless your property value is increasing, a reverse mortgage uses up the equity in your home. When you die, your heirs may have to sell the home if they can’t afford to repay the debt. This may leave them with little or nothing to inherit from you.
- Fees. Similar to traditional mortgages, you’ll incur some costs when securing a reverse mortgage loan. Some of these costs include mortgage insurance premiums, origination fees, servicing fees, third-party fees, and closing costs.
What Can a Reverse Mortgage Be Used for?
Regardless of why you need financial assistance to fund a comfortable retirement, you can use a reverse mortgage for various purposes, including:
- Consolidating your debts.
- Paying for repairs or making home improvements.
- Paying for in-home care.
- Supplementing your retirement income.
- Increasing savings or creating an emergency fund.
- Eliminating or reducing your monthly mortgage payments.
Remember, you can use home equity conversion mortgages for any purpose. However, if you take out a single-purpose reverse mortgage, your lender may specify how you can use the funds.
Is a Reverse Mortgage Right for You?
A reverse mortgage can be a last-ditch ticket to raising money for daily expenses. However, this isn’t an easy decision. You could end up spending a huge portion of the home equity you’ve worked so hard to accumulate. So how do you know a reverse mortgage is right for you?
- You don’t plan to move. You can take out a reverse mortgage loan if you have no intention of moving out of your home. A reverse mortgage has huge up-front costs, including origination fees, upfront mortgage insurance, and closing costs. It doesn’t make any financial sense to pay all these costs if you will move out soon.
- You can pay the ongoing costs. A reverse mortgage doesn’t get you off the hook for property taxes, homeowners’ insurance, homeowners’ association fees, or home maintenance. Falling behind on any of these may cause your lender to declare your loan due and payable. If you can afford to pay these ongoing costs of home ownership, a reverse mortgage may do you good.
- Your spouse is at least 62 years old. You must be 62 or older to take out a reverse mortgage. However, a reverse mortgage isn’t a good choice if your spouse isn’t yet 62 years old. Sure, they won’t lose the home if you pass away first, but they could easily lose a source of income they were depending on before you passed.
What Can Go Wrong with a Reverse Mortgage?
A reverse mortgage can give retirees additional income by helping them access the equity in their homes. On the flip side, it’s not all glamor with reverse mortgages, and things could go wrong. First, your heirs may have nothing to inherit. Usually, the reverse mortgage must be repaid when you die, and this may mean selling the house. If the house sells for less than the outstanding loan balance, your heirs will receive nothing.
You can obtain a reverse mortgage to raise cash for medical bills, but there’s a catch: you must be healthy enough to continue living in the home. If your health deteriorates to the point that you must relocate to a healthcare facility, your loan comes due.
The proceeds of your reverse mortgage may be inadequate to pay property taxes, homeowners’ insurance premiums, and the other costs of home ownership. Your loan may come due if you don’t keep up with these costs, and this could cause you to lose your home.
Watch out for reverse mortgage scams. For instance, contractors may approach you about obtaining a reverse mortgage loan to cover repairs for your home. This could be a scam, and you shouldn’t be coerced into taking out a reverse mortgage loan.
Alternatives to a Reverse Mortgage
Homeowners considering a reverse mortgage may find other housing or loan choices are a better fit for their personal needs or financial situation. Some alternatives to a reverse mortgage include:
- Refinancing. A reverse mortgage may lower or eliminate the monthly payments to your mortgage lender, but refinancing your current mortgage may help you lock in a lower monthly mortgage payment. Be sure to check the terms of your new mortgage because it may trickle into your retirement plan. A shorter-term mortgage may be a great choice.
- Downsizing. A bigger home may mean more equity, but it could also translate to more expenses, such as maintenance costs and higher premiums. Selling your home and moving to a more affordable home may help you cut expenses and leave you with more money to sustain your lifestyle.
- Other home equity options. A home equity line of credit (HELOC) or home equity loan may be a cheaper way to take out cash against the equity in your home. However, you’ll still need to make monthly payments to your lender.
- Waiting. You may not need a reverse mortgage loan as soon as you retire. Instead, you may run out of cash down the road when your healthcare bills are higher.
- Seeking assistance. Some local and state programs may provide assistance with utilities and home repairs. Many local government agencies also run programs that help with property taxes. Check with your local tax office.
Conclusion and Recommendations
A reverse mortgage can be a good idea if you’re a senior who needs additional income but plans to stay put in their home. However, there are pitfalls, including upfront and ongoing costs, variable interest rates, and the potential to leave your heirs with no assets.
When deciding whether to take out a reverse mortgage, remember that the main benefit is giving you money to use now, so you won’t have as much saved in the future. Explore other housing or borrowing choices so that your finances don’t take a nosedive. And if you’ve already locked in a loan, you have three business days to cancel the deal without penalty.