A reverse mortgage is a unique type of loan that allows homeowners aged 62 and older to tap into their home equity without having to make monthly payments. With a reverse mortgage, the lender pays you either a lump sum, regular payments, or a line of credit. You don’t have to repay the loan until you permanently move out, sell the home, or pass away.
Reverse mortgages can provide retirees with extra income to cover expenses in retirement. But like any financial product, they also come with drawbacks and risks. If you’re considering a reverse mortgage, it’s essential to weigh the pros and cons to determine if it’s the right move for your situation.
What is a Reverse Mortgage?
Before diving into the pros and cons, let’s make sure you understand exactly what a reverse mortgage is.
A reverse mortgage is a loan secured by your home that you receive from a lender. However, unlike a traditional “forward” mortgage, you don’t make monthly payments on a reverse mortgage. Instead, the balance grows over time as interest accrues.
The most common type of reverse mortgage is called a Home Equity Conversion Mortgage (HECM). These are insured by the Federal Housing Administration (FHA).
To qualify for a reverse mortgage, you must:
- Be 62 years of age or older
- Have substantial equity built up in your home
- Use the home as your primary residence
- Be able to pay property taxes, insurance, HOA fees
- Complete reverse mortgage counseling
You can receive your reverse mortgage funds as:
- A lump sum payment
- Regular monthly payments
- A line of credit
- A combination of the above
The loan only becomes due for repayment when the last surviving borrower dies, sells the home, or permanently moves out.
Now that you understand the basics, let’s take a look at the biggest pros and cons of reverse mortgages.
Pros of Reverse Mortgages
Here are some of the top advantages of reverse mortgages:
1. Provides Tax-Free Income in Retirement
The funds you receive from a reverse mortgage are not considered taxable income. This is because reverse mortgages are classified as loan advances rather than income.
This can be a major benefit for retirees needing extra funds to cover expenses. The payments you receive won’t be taxed and won’t impact your Social Security or Medicare benefits.
2. Allows Seniors to Age in Place
One of the major appeals of a reverse mortgage is the ability to tap home equity without having to sell your house and move elsewhere. This can provide peace of mind knowing you can stay in your home for as long as you want.
3. Can Be Used to Pay Off Debts
If you have high-interest debt, an outstanding mortgage balance, or other bills you’re struggling with, a reverse mortgage can provide funds to pay those off. This may allow you to have lower fixed expenses going forward.
4. Helps Manage Unexpected Expenses
Reverse mortgages provide access to funds that can be critical in managing unexpected medical bills or other surprise costs that may come up in retirement. This can help avoid draining your retirement savings.
5. Doesn’t Require Monthly Payments
Unlike traditional home equity loans or lines of credit, reverse mortgage borrowers aren’t required to make monthly payments. This reduces the risk of default, as the loan simply accrues interest until you sell the home or pass away.
6. Protects Against Owing More Than Home’s Value
Reverse mortgages are considered non-recourse loans, meaning the total amount owed can never exceed the value of the home. This protects you and your heirs from being responsible for any shortfall.
Cons of Reverse Mortgages
However, reverse mortgages also come with some disadvantages to be aware of:
1. Shrinks Your Home Equity
With a reverse mortgage, your loan balance grows over time while your equity shrinks. This means you or your heirs will have less equity remaining when the home is eventually sold.
2. Results in Less Inheritance for Heirs
Because reverse mortgages reduce the amount of home equity remaining, your heirs will likely receive less money from the estate. In some cases, the entire home value may be owed to the lender.
3. Carries High Upfront Costs
Reverse mortgages come with origination fees, closing costs, and mortgage insurance premiums that can total thousands. These upfront costs make the loans expensive compared to alternatives.
4. Requires Paying Property Taxes and Insurance
If you fall behind on property taxes, insurance, HOA fees, or home maintenance, you risk default and foreclosure on a reverse mortgage. This remains your responsibility.
5. Could Impact Need-Based Benefit Eligibility
While reverse mortgage funds aren’t taxed, they could impact your eligibility for means-tested programs like Medicaid or Supplemental Security Income (SSI) depending on how proceeds are used.
6. Requires Repayment Upon Moving Out
If you need to move to an assisted living facility or nursing home, the loan immediately becomes due. This also applies if you need to be away from the home for more than 12 consecutive months.
Who Should Consider a Reverse Mortgage?
Reverse mortgages can be a smart option for retirees in some situations but a poor choice in others. You may want to consider a reverse mortgage if:
- You have extensive home equity built up
- You don’t intend to move anytime soon
- You need extra retirement income to cover expenses
- You lack cash/investments beyond your home
- Paying a mortgage/bills is difficult on a fixed income
Seniors who have minimal equity in their home or anticipate needing to move in the near future are likely better off exploring other options.
Alternatives to Reverse Mortgages
Reverse mortgages aren’t the only way to tap home equity. Some alternatives include:
- Home Equity Loan – Must make payments, requires income/credit qualification
- HELOC – Revolving credit line, requires income/credit qualification
- Cash-Out Refinance – Must make payments, requires income qualification
- Selling Home – Relocate to less expensive area or downsize
These alternatives come with monthly payments but may provide lower costs and less risk compared to reverse mortgages.
Key Takeaways on Reverse Mortgages
- Provides tax-free income and allows aging in place
- Helps manage expenses but reduces equity and inheritance
- Best for seniors who need funds and don’t intend to move
- Requires paying property taxes, insurance, and home costs
- Alternatives like HELOCs may offer lower long-term costs
- Important to weigh pros and cons for your specific situation
Reverse mortgages can be a valuable financial tool for some retirees but also come with significant risks. Seniors interested in a reverse mortgage should carefully consider both the benefits and drawbacks before moving forward. Consulting with financial and legal advisors is highly recommended when evaluating if a reverse mortgage aligns with your overall financial plan.
Frequently Asked Questions (FAQs)
How much money can I get from a reverse mortgage?
The amount you can borrow depends on your age, home value, interest rates, and how much equity you have. Generally you can receive 10-60% of your home’s value in cash. An older borrower with more home equity qualifies for more funds.
Can I lose my home with a reverse mortgage?
You can lose your home to foreclosure if you fail to pay property taxes, insurance, HOA fees, or fail to maintain the home. You must continue meeting these obligations to avoid default.
Do heirs have to pay off a reverse mortgage?
When you pass away or move out permanently, heirs can either pay off the balance or surrender the home to satisfy the debt. Any remaining equity after repaying the loan goes to your estate.
Is the money from a reverse mortgage taxable?
No, reverse mortgage funds are not considered taxable income. The money is classified as loan proceeds rather than income. It does not impact your tax liability or benefits.
How long can I stay in my home with a reverse mortgage?
You can remain in your reverse mortgage home for as long as you’d like, provided you continue to pay taxes, insurance, HOA fees and maintain the property. There is no set repayment date with a reverse mortgage.
