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. There are two sides to every financial product, however, so consider the pros and cons of a reverse mortgage carefully.
What is a reverse mortgage?
A reverse mortgage allows property owners 62 and older to convert real estate equity into spendable cash.
The vast majority of reverse mortgages are insured through the Federal Housing Administration, (FHA), which means if the debt is not repaid by the borrower, it will be repaid with FHA reserves.
The government calls reverse mortgages “HECMs,” which stands for Home Equity Conversion Mortgages, and borrowers must pay an insurance upfront premium and an annual premium of 0.5 percent of the outstanding loan to participate. These premiums are used to fund the FHA’s reserves.
In addition to FHA-insured reverse mortgages, there are two other types:
- Proprietary reverse mortgages – These are available through private lenders, and they are not subject to FHA loan limits.
- Single-purpose reverse mortgage – These are not as common, and the money you obtain from one of these can only be used for one specific need, such as renovating part of your home or paying your property taxes. You can find these options via some state and local governments and non-profit organizations.
How do reverse mortgages work?
A reverse mortgage gives you access to funds without sending you an immediate bill.
Consider this math: With a traditional mortgage, if you borrow $100,000 at 3.4 percent fixed interest for 30 years, you’ll have a $443.48 monthly payment (principal and interest). If you borrow $100,000 with a reverse mortgage, your required monthly payments for principal and interest are zero.
Too good to be true? Well, yes. You will still owe money. You just won’t have to pay it back until you sell the home, move out or die. If the latter is the end of your reverse mortgage, the payoff responsibility falls on your spouse or heirs who may need to sell the home.
With our example $100,000 mortgage, the borrower pays about $443 each month. Of this amount, around $160 is paid toward principal in the first month to reduce the loan balance. The rest of the payment — approximately $283 — is interest, or what the lender charges you for loaning you money. The payment plan continues like this every month, with more of the payment going to the principal and less to interest over time, until the loan term is up.
With a reverse mortgage, the process is flipped. Instead of making a payment each month, you will pay nothing. This doesn’t mean the loan is free, however. The interest cost is added to the mortgage balance, so in the second month, the balance grows. Since the loan balance is now a little bigger, the interest cost is a touch higher, and this process continues until the time comes for the loan to be repaid. That repayment usually happens within one year of when you move out of the property or when you die.
Pros of a reverse mortgage
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 finding a new, more affordable 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 cheaper 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 in size, it’s possible that it can exceed the fair market value of the property over time. 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).
Cons of a reverse mortgage
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 can’t get as much with the fixed-rate option
HECMs are structured so that both adjustable-rate and fixed-rate financing options are available. If you want fixed-rate financing, though, the amount of equity you can access is smaller than what you could tap with an adjustable-rate reverse mortgage.
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 is complicated stuff, so be sure to speak with an attorney who specializes in elder law or a legal clinic before searching for a reverse mortgage program.
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. Not so. Seniors can have their homes foreclosed if they do not pay property taxes or maintain homeowners insurance or fail to pay HOA dues.
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 (which seems to be quite a few places around the country right now), 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.
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 less-than-perfect 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: Recently, the Consumer Financial Protection Bureau filed a complaint and levied a $1.1 million fine against American Advisors Group, one of the biggest names in reverse mortgages, for deceptive marketing.
So, the simple rule: Be very, very cautious about putting your home at risk.
Still, there are two key reasons that seniors might consider examining their reverse mortgage options today:
- Elevated equity – Over the past decade, home equity has grown as home values have risen. The average American homeowner gained more than $56,000 in equity between the third quarter of 2020 and the third quarter of 2021, according to CoreLogic.
- Record-low interest rates – While interest rates are beginning to rise and will likely continue on that path in 2022, it’s still a cheap time to borrow money. Interest rates on 30-year loans are currently estimated to stay below 4 percent throughout the next year.
Remember that you have other options to access cash, too. Compare a home equity loan versus a reverse mortgage to see which one is a better fit for your needs.
With additional reporting by David McMillin