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- If you’re a homeowner aged 62 or older, a reverse mortgage can help you obtain non-taxable money, allowing you to stay in your home, pay bills and supplement your income.
- A reverse mortgage isn’t ‘free money’: Borrowing costs can be high, and you still have other home maintenance expenses.
- Reverse mortgages can also complicate life for your survivors after you die or permanently leave the home.
If you watch TV, you’ve likely seen well-known actors like Tom Selleck and Henry Winkler touting reverse mortgages as a valuable income source for anyone retired or with limited funds. This sort of loan allows property owners 62 and older to borrow against the equity in their homes, receiving regular tax-free payments to use as they wish. Repayment is only due when the borrower dies or permanently vacates the home, or sells it.
It sounds good, and it can be. But it’s crucial to thoroughly understand the good and bad components of a reverse mortgage before you or people close to you take one out. Here are the pros and cons to consider.
HECM loans tend to have lower interest rates, while non-HECM loans offer larger sums and more flexible terms (available to younger homeowners, for example). “The vast majority of reverse mortgages are HECM,” van den Brand notes.
Reverse mortgage pros
You can better manage expenses in retirement
Many seniors experience a significant income reduction when they retire. A reverse mortgage lets you supplement a diminished income without digging into savings. You don’t have to make monthly payments, not even of interest (usually).
You don’t have to move
Instead of leaving your home, a reverse mortgage allows you to age in place. Additionally, while a reverse mortgage comes with fees and other costs, it might cost less in the long run than buying another home or rent in a new location.
You don’t have to pay taxes on the income
The money you get from a reverse mortgage isn’t taxable because the IRS considers it “loan proceeds,” not income. However, it could be considered income by other agencies (see “Reverse mortgage cons,” below).
You’re protected if the balance exceeds your home’s value
Because a reverse mortgage balance grows over time (if you make no repayments), it’s possible that it can exceed your home’s fair market value eventually. 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. That also means a mortgage lender can have no claims against your other assets or your heirs’.
Your heirs have options
Reverse mortgages can be paid off by borrowers, 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 repay the debt out of pocket; 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 (or they don’t want the house), they can let the lender assume the property title. 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 a lot
One of the problems of reverse mortgages are the costs associated with them. Reverse mortgages come with lender fees (though origination fees are capped at $6,000 and depend on the amount of your loan), mortgage insurance premiums (similar to the MIP on FHA loans) and closing costs. Many of these expenses can be rolled into the loan principal; however, that can substantially increase the amount you owe. 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 the loan is paid in full.
You could inadvertently violate other program requirements
A reverse mortgage could cause you to violate asset or income restrictions for the Medicaid and Supplemental Security Income (SSI) programs. This might affect your eligibility for these benefits.
You still have home expenses
A reverse mortgage doesn’t get you off the hook for home maintenance expenses. Property taxes, homeowner’s insurance premiums and HOA fees are all still your responsibility.
If you default on or fail to pay any of these expenses in a timely manner, it violates the reverse mortgage agreement and your home could be foreclosed upon.
Your survivors could be in for nasty surprises
When the borrower is no longer living in the home, the reverse mortgage either has to be repaid in full or the home surrendered to the lender. This scenario could be triggered by death (obviously), but also by going into a nursing home or a long-term care facility.
This situation can cause complications for those non-borrowers still living in the home. While there are protections in place for surviving spouses, they only apply if you were married prior to obtaining the reverse mortgage.
And the amount to repay could be a lot larger than you anticipated — or actually received. Remember, interest accrues on reverse mortgages. If you never made any repayments, or only minimal ones, the loan balance can look perplexing high when it’s payback time.
It’s for this reason that borrowers are required to get counseling before taking out a reverse mortgage, to understand all the consequences of this sort of financing. You might also want to consult a real estate attorney or one who specializes in elder law or estate law.
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 “break even” on 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.
- You need more money to manage everyday expenses – A reverse mortgage can help give you cash to help deal with bills if you’ve found yourself struggling on your limited income, especially as many categories like groceries and gasoline are reflecting inflation thesed days.
- Your home is increasing in value – 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.
Who is a bad candidate for a reverse mortgage?
There are plenty of signs that a reverse mortgage is not a good choice:
- 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.
- 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 in full.
- You’re struggling to cover other ongoing home costs of your home – If you’re challenged coming up with the cash for essential costs like property taxes and homeowners insurance — not to mention mortgage repayments, if you still have a primary loan — adding to your debt should not be on the table.
How to get a reverse mortgage
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.
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, the value of homeownership stakes 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.