Is a Reverse Mortgage the Best Option?
By: Financial Hotline
Summer 2023 (Vol. 41, No. 2)
Home equity represents a significant portion of the average retiree’s wealth. If you’re 62 or older and house-rich but cash-poor, a reverse mortgage loan allows you to convert part of the equity in your home into cash - without having to sell your home. You can use this cash to finance a home improvement, pay off your current mortgage, supplement your retirement income, or pay for healthcare expenses. A reverse mortgage is not without risk, however. Reverse mortgages operate like traditional mortgages, only in reverse. Rather than paying your lender each month, the lender pays you. There are three types of reverse mortgages available. The most common is the Home Equity Conversion Mortgage (HECM) insured by the federal government, but it may include higher monthly fees. You can forego private mortgage insurance premiums if you choose to use a private lender (Proprietary Reverse Mortgage) that is not FHA insured, or a Single-Purpose Reverse Mortgage that are offered by state and local governments or non-profits.
The primary benefit of a reverse mortgage is that it allows eligible homeowners to keep living in their homes and use their equity for whatever purpose they choose. Depending on the lender, borrowers can choose to receive monthly payments, a lump sum, a line of credit, or some combination of these. Reverse mortgages differ from home equity loans in that most reverse mortgages do not require repayment of principal, interest, or servicing fees if you live in the home. Instead, the loan is repaid when you die or sell the home.
The proceeds of a reverse mortgage generally are tax- free, and interest on reverse mortgages is not deductible until you pay off the debt. When you die or move out, the loan is paid off by selling the property. Any leftover equity belongs to you or your heirs. If you receive Social Security Supplemental Security Income, reverse mortgage payments do not affect your benefits if you spend them within the month they are received. This rule is also valid for Medicaid benefits in most states.
To be eligible for a reverse mortgage, generally you must:
- Be 62 years of age or older.
- Either completely own your home or meet applicable equity requirements.
- Live in the home.
- Be able to pay property taxes and other expenses associated with the property, such as insurance, maintenance and repairs, and any homeowner association fees.
Maximum loan amounts range (depending on the lender) from 50% to 75% of the home’s fair market value. All reverse mortgages have nonrecourse clauses, meaning the debt cannot exceed the home’s value. Maximum loan amount limits are based on the value of the home, the borrower’s age and life expectancy, the loan’s interest rate, and whatever the lender’s policies are.
There are downsides to reverse mortgages. If you already have a substantial mortgage on your home or you plan to move a few years down the road or there is a possibility you will have to move due to illness or any other unforeseen event, then a reverse mortgage probably doesn’t make sense. Several additional downsides of reverse mortgages include:
- Increasing Debt. Reverse mortgages (fixed-rate or adjustable-rate) are rising-debt loans in that the interest is added to the monthly loan balance. Because it is not paid currently, the total interest you owe increases greatly over time as the interest compounds.
- Less inheritance. If you want to pass your home to your children or other heirs, the reverse mortgage is not a good choice because the lender could get most of the equity when the home is sold, leaving fewer assets for your heirs.
- Higher Costs Up Front. The high up-front costs of reverse mortgages may make them less attractive to some people. All three types of plans charge an origination fee, interest rate, closing costs, and servicing fees. Insured plans also charge insurance premiums.
- Complicated terms. Many loans are difficult to understand, and you may end up with less money coming in or unexpected fees or restrictions. If you don’t keep up the maintenance and pay your insurance and taxes on time, you could be at risk for losing your home.
- Adjustable vs. Fixed Interest Rates. With many reverse mortgage plans, interest rates are adjustable annually or monthly and tied to a financial index, sometimes with limits on how far the rate can go up or down. Reverse mortgages with interest rates that adjust monthly may have no limit.
- Loss of alternative sources of income. The income could impact your ability to qualify for government programs such as Medicaid or Supplemental Security Income or community-based services such as free meals or housing assistance.
- Beware of Scams. Because these are complicated loan programs, they are commonly used in scams that prey on older citizens.
Reverse mortgages are a complex financial tool that may be the answer for some house-rich and cash-poor retirees planning to age in place, but they are not for everyone. If you need more income, a Reverse Mortgage is an easy option, but it may not be the best. Consider these alternatives:
- Sell your home and downsize. A cheaper, smaller home may free up cash and save money on insurance, taxes, and upkeep.
- Sell your home with a long-term leaseback. A neighbor or family member may be the first choice for this strategy, but an investor may be interested as well. Get a lump sum cash payment plus a landlord to maintain the upkeep on the home.
- Rent a room for additional income. In today’s high priced rental market, taking on a renter can bring in substantial income.
- Refinance your current mortgage to lower your current payments or change your loan term. A home equity loan or cash-out refinance would allow you to borrow funds needed for improvements or other pressing costs.