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Reverse Mortgage: Pros and Cons
You hear a lot about mortgages these days, but you don’t hear much about reverse mortgages. Reverse mortgages are a unique type of mortgage that’s limited in scope and who can qualify. Unlike a typical mortgage, which provides you with a loan to buy a home, a reverse mortgage lends the homeowner money from the equity they’ve built in their home.
Reverse mortgage loans can be an effective tool for older homeowners who don’t have much spare cash but need to cover expenses such as medical bills, home renovations and monthly bills. The catch is that these types of loans are only available to homeowners age 62 or older.
Needless to say, these loans aren’t for everyone — in part because not everyone can qualify. But there are other pros and cons of a reverse mortgage that homeowners should consider as well before jumping in head-first into this type of loan.
What is a reverse mortgage?
A reverse mortgage is a type of home loan where the homeowner borrows against the equity in their home, but unlike your traditional home equity loan, the homeowner doesn’t pay the reverse mortgage back until the home is sold or inherited. In other words, homeowners who use reverse mortgages trade their equity for cash.
Reverse mortgages are a unique type of loan in that they’re only available to homeowners age 62 or older. As a result, most people aren’t eligible. Those who utilize this type of loan often use the money to pay off debt or cover their living expenses during retirement.
When someone takes out a reverse mortgage, they can get the cash either as a single lump sum, in fixed monthly payments or as a revolving line of credit to use when they need it.
Unlike most loans, the borrower doesn’t have to start paying it back right away. In fact, reverse mortgages don’t have to be paid back until the borrower dies, sells the home or moves out. Heirs often end up paying off the loan with the sale of the house after the original borrower passes away.
There are three types of reverse mortgages: single-purpose reverse mortgages, proprietary reverse mortgages and Home Equity Conversion Mortgages.
A single-purpose reverse mortgage can only be used for one purpose, which is specified at the beginning of the loan. For example, someone might take out a single-purpose reverse mortgage to consolidate their debt or renovate their home.
A proprietary reverse mortgage is a loan from a private mortgage lender, and it allows the borrower to do whatever they want with the money.
Finally, a Home Equity Conversion Mortgage is a federally-insured loan that can be used for any purpose.
Benefits of a reverse mortgage
Reverse mortgages can be beneficial for homeowners age 62 or older who are struggling to make ends meet. First and foremost, these loans put money in the hands of people who need it. Data shows that more than 25 million Americans age 60 or older are economically insecure, meaning they’re living at or below 250% of the federal poverty level.
Since many of these individuals no longer work, it can be hard to come up with alternative income sources. Reverse mortgages can act as a tax-free income stream and help seniors to pay their monthly bills.
Many of the other options available to seniors require them to sell their homes and move in with family or into assisted living homes. As long as they already have equity in their homes, though, a reverse mortgage can help those people to stay in their homes.
Another perk of reverse mortgages is that borrowers don’t have to start paying the money back right away. Instead, homeowners can take the cash and consider it a permanent reduction in their home equity. Then, when the homeowner dies or sells the home, the loan can be paid back using the sale of the house.
Some of the benefits of choosing a reverse mortgage include:
It eases money issues in your golden years.
If medical bills are an issue or retirement funds aren’t accessible, a reverse mortgage can give a homeowner peace of mind that there are funds to live on. It is guaranteed money — which can take some of the financial stress off of your later years.
You retain the title to your house.
Unlike an apartment or other rentals, you cannot be evicted by the lender who is making the reverse mortgage payments. As long as you keep up with any loan obligations, taxes, insurance and homeowners association fees, the reverse mortgage works in your favor.
It is a non-recourse loan.
A non-recourse loan means that you and your heirs are liable for any overage that exceeds the home’s value after it is repaid. A reverse mortgage could work out profitably in the long run, depending on what your financial advisor thinks.
A reverse mortgage should not affect Social Security benefits or Medicare eligibility.
A reverse mortgage should not, in most cases, affect the benefits you’re receiving. Much of this depends on where you live and the number of reverse mortgage payouts you’re receiving, but in most cases, a reverse mortgage won’t negatively affect your benefits. It is vital to speak with someone in your area who knows the regulations in order to confirm, though.
You choose the payment schedule or types of payments.
Borrowers with a fixed-rate loan get a single lump sum reverse mortgage payment as part of the agreement with the lender. Adjustable-rate mortgages differ in that you can choose to receive monthly payments, a lump sum or a line of credit. It is also possible for the borrower to combine the three different payment types with an adjustable-rate mortgage.
Drawbacks of a reverse mortgage
While reverse mortgages can be extremely beneficial for seniors, there are some downsides as well. Despite the fact that the borrower doesn’t have to pay back the loan right away, it’s not free money. Eventually, someone will have to pay back the loan.
It’s not just the money borrowed that they’ll have to pay back, either — reverse mortgages also come with fees, closing costs, and of course, interest. When compared with alternatives like home equity loans, reverse mortgages typically have higher fees and closing costs.
Another thing to consider with reverse mortgages is what happens if the loan amount runs dry during your lifetime. In that case, you end up with no money left and no equity in your home. When you sell the house, you won’t have any money left over after paying back your loan.
Some of the other drawbacks of choosing a reverse mortgage include:
The interest can be sky-high.
A reverse mortgage is a loan — it’s just a more nuanced type. Like any loan, there is interest on the amount of money you’re borrowing and fees can accumulate. Your home’s equity may not benefit from such a deal in the long run — which could mean that you’ll have less to bank on when you sell your home later on in life.
You have to stay put in your home.
A reverse mortgage means the borrower must stay in the home. If it is sold or used as a rental, then the mortgage payments may be pulled immediately by the lender. You need to be aware of this fact if you’re planning to move or leave your property in the next few years.
It is only for people of retirement age.
The minimum age at which you can qualify for a reverse mortgage loan is 62. There are no exceptions. The titleholder of the home must be that age and not any younger or you can’t qualify.
Taking out a reverse mortgage means less money to leave any heirs.
A reverse mortgage is dependent on home equity, which means that if you utilize this type of loan, there may be fewer assets to leave if you pass away. This type of loan is typically repaid by selling the house. But suppose your heirs have any sentimental attachment to your home. In that case, it may not wind up in their hands unless the loaning institution agrees to sell it to them to recoup the loan amount.
Read the fine print.
Every reverse mortgage lender has a set of rules for the borrower. If taxes or HOA fees lapse, the borrower may rescind the loan. Being unable to maintain the property and thus keeping up its equity can also cause the loan to be stopped by the lender. Suppose the borrower must leave home for a hospital stay of more than 12 months or even leaves home for more than six months a year to live elsewhere. In that case, this is considered a “maturity event,” and the loan will need to be repaid immediately.
Who should get a reverse mortgage
Now that you’ve learned the pros and cons of reverse mortgages, how do you know when they’re the right choice for you?
Reverse mortgages are ideal for two types of homeowners:
- Homeowners who need a source of income during retirement. One of the perks of a reverse mortgage is that you can borrow the money in the form of a fixed monthly payment. For those who need another income stream to supplement their Social Security checks, reverse mortgages can be a good choice. Unlike other types of income, borrowers don’t have to pay income taxes on these funds.
Homeowners who need a loan and aren’t sure when they’ll be able to pay it back. If you’re borrowing money to renovate your home or pay off debt, there are cheaper ways to do it. Home equity loans and home equity lines of credit allow homeowners to borrow against their home equity for lower fees and closing costs than reverse mortgages. The advantage of a reverse mortgage is that you don’t have to pay it back until you sell the home, so if you need money and don’t know for sure that you’ll be able to pay it back right away, a reverse mortgage can help provide you the cushion you need.