Reverse mortgage pros and cons
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If you watch any television, you’ve likely seen well-known voices like actor Tom Selleck touting reverse mortgages as a valuable tool for anyone in retirement. This financial product allows property owners 62 and older to convert real estate equity into spendable cash. While you’ll still owe money when you move or pass away, you won’t have a monthly payment until then.
- If you're a homeowner age 62 or older, a reverse mortgage can help you obtain tax-free income based on the equity in your home.
- A reverse mortgage might give you more flexibility in retirement and allow you to stay in your home. While you won't have a monthly payment, you'll need to keep up with homeowners insurance premiums, property taxes and home maintenance expenses or risk losing your home.
- A reverse mortgage isn't "free money." It's crucial to thoroughly understand the pros and cons before utilizing this product.
Reverse mortgage pros
You can better manage expenses in retirement
Many seniors experience a significant income reduction when they retire, and monthly mortgage payments can be their biggest expense. With a reverse mortgage, you can supplement a diminished income and continue to pay your bills.
You don’t have to move
Instead of leaving your home, a reverse mortgage allows you to age in place (and potentially stay near friends and family). Additionally, while there’s a cost to a reverse mortgage, it might be cost less in the long run to get a reverse mortgage than to move and either buy another home or rent in a new location.
You don’t have to pay taxes on the income
The income you get from a reverse mortgage isn’t taxable because the IRS considers the money “loan proceeds.” Tax rules can be complicated, however, so be sure to see a tax professional for advice before committing to a reverse mortgage.
You’re protected if the balance exceeds your home’s value
Because a reverse mortgage balance grows over time, it’s possible that it can exceed the fair market value of the property. However, the amount of debt that must be repaid can never exceed the property’s value, because a reverse mortgage is an example of “non-recourse” financing. The result is that a mortgage lender can have no claims against your other assets or heirs in this scenario.
Your heirs have options
Reverse mortgages can be paid off by borrowers sooner, but typically end when the borrower moves, sells the home or passes away. In an estate situation, heirs have several choices: They can sell the property to repay the debt and keep any equity above the loan balance; they can keep the home and refinance the reverse mortgage balance if the property’s value is sufficient; or, if the debt exceeds the value of the property, heirs can settle the loan by giving the title back to the lender. The lender can then file a claim for any unpaid balance with the insurer (almost always the FHA).
Reverse mortgage cons
You have to pay for it
Reverse mortgages have costs that include lender fees (origination fees are capped at $6,000 and depend on the amount of your loan), FHA insurance charges and closing costs. These costs can be added to the loan balance; however, that means the borrower would have more debt and less equity. You’ll also be paying pesky servicing fees each month that can be as high as $35 if your interest rate adjusts on a monthly basis.
You can’t deduct the interest from your taxes until you pay off the loan
You might have enjoyed the mortgage interest deduction on your taxes when you were paying off your mortgage, but you will not be able to deduct the interest on a reverse mortgage each year. You’ll only enjoy that perk when you’re actually paying off the loan.
You could inadvertently violate other program requirements
Simply put, a reverse mortgage could cause you to violate asset restrictions for the Medicaid and Supplemental Security Income (SSI) programs. This might affect your eligibility for these benefits.
Your home can be foreclosed
Since reverse mortgages don’t have required monthly payments for principal and interest, it might seem as though foreclosure is impossible. However, this is not the case; foreclosure can happen if you fail to keep up with property taxes, homeowner’s insurance or required HOA fees.
You could have a hard time navigating changes to your status
Reverse mortgages can be complicated, and if something changes with your status, your reverse mortgage options can change, too. If you go to a long-term care facility, for example, would you still be considered a resident in your home? If you marry after obtaining a reverse mortgage, must your spouse move out of the property if you die? For details regarding these and other questions, it’s best to speak with a lender or an attorney who specializes in elder law, or contact a pro-bono legal clinic.
Who is a good candidate for a reverse mortgage?
With all the potential complexities and risk of putting your home on the line, is a reverse mortgage actually a good idea? For some homeowners, the answer might be yes:
- If you anticipate staying in your home for a long time – Since you’ll pay another set of closing costs with a reverse mortgage, you need to stay in the home long enough to justify the expense. So, if you’re 62, have a history of longevity and believe your current place is your forever home, a reverse mortgage could make sense. Plus, if you live in a market where home values are appreciating at a fast clip, your property may be worth plenty more by the time you or your heirs pay back the loan.
- If you need more money to manage everyday expenses – If you’ve found yourself struggling to manage the expenses of retirement, a reverse mortgage can help give you liquid cash to help deal with those responsibilities. With the Consumer Price Index reflecting a sharp uptick in many expense categories like groceries and gasoline, this may be an urgent need for you.
Who is a bad candidate for a reverse mortgage?
There are plenty of signs that a reverse mortgage is not a good choice:
- If you’re planning to move – Remember that you need a long runway to make paying all the closing costs, mortgage insurance premiums and other fees worth it. So, if you think you might want to relocate to a new destination or downsize to a smaller place anytime soon, steer clear of a reverse mortgage.
- If you might need to move due to health issues – A reverse mortgage requires you to live in the home, which means that relocating to a nursing home or any kind of assisted living arrangement could result in needing to pay back the loan. If you’ve been concerned about health issues, it’s probably wise to avoid a reverse mortgage.
- If you’re struggling to cover the other costs of your home – One of the key components of a reverse mortgage is your ability to pay your property taxes and homeowners insurance. If you’ve faced challenges coming up with the cash for these essential costs, adding to your debt should not be on the table.
How to get a reverse mortgage if it’s right for you
If you’ve considered all the pros and cons and believe a reverse mortgage will be good for you, follow these steps to get one:
- Figure out if you’re eligible. To get a reverse mortgage, you’ll need to satisfy a few key requirements: be at least 62 years old, live in your home and have a substantial amount of equity (typically at least 50 percent).
- Meet with a HUD-approved financial counselor. Because reverse mortgages are so complex, you’ll need to meet with an expert who can explain all your options.
- Compare multiple lenders. Every lender is different and charges a different set of fees. Make sure you look at a number of options to find the lowest origination fees and closing costs and the most competitive interest rate.
- Talk it over with your heirs. If you’re aiming to leave your property to someone in your family, you should discuss your reverse mortgage plans with them. Make sure they understand the implications and what they will need to do when you die.
Bottom line: Should you get a reverse mortgage?
Reverse mortgages have gained a reputation thanks to some scams that target unsuspecting seniors. Even legitimate companies have used dishonest marketing to try to get homeowners to take out reverse mortgages. The simple rule is: Be very, very cautious about putting your home at risk.
Still, there is one key reason that seniors might consider examining their reverse mortgage options today: elevated equity. Over the past few years, equity has grown as home values have skyrocketed.
Remember that you have other options to access cash, too. Compare a home equity loan versus a reverse mortgage to see which one might be a better fit for your needs.
With additional reporting by David McMillin and Meaghan Hunt