What is a reverse mortgage and how does it work?
A reverse mortgage is a type of loan that allows eligible seniors to tap into their home equity without the obligation of monthly payments. Traditional mortgages pay down the balance over the life of the loan, but the balance of a reverse mortgage grows over time as interest charges increase the amount owed.
To qualify for a reverse mortgage, you must be at least 62 years old and have equity in your home. The borrower can live in their home for as long as they like. However, the reverse mortgage must be repaid if the borrower moves out, sells the home or dies. Borrowers or their heirs can pay off the loan with cash or a new mortgage to retain ownership of the home.
Casey Fleming, a mortgage advisor and the author of "The Loan Guide: How to Get the Best Possible Mortgage," advised that "a reverse mortgage is a lifetime loan, meaning that as long as you live in the property, maintain it and pay your taxes and insurance, it cannot be called or terminated. However, if you move out for more than 12 months, the loan is now due and payable. You have six to 12 months after it's called to come up with a plan to pay it off."
» COMPARE: Best reverse mortgage lenders
Pros of a reverse mortgage
Reverse mortgages offer a financial cushion to elderly homeowners who want to continue living in the same homes. The advantages of using this mortgage option over more traditional home loans include:
Borrowers can choose how to access their equity
Reverse mortgages can be a stream of income, a lump sum or a line of credit. You will also have control over how you use your money — whether you spend it on debt consolidation, medical bills or a fun trip is up to you.
It’s not counted as income
Since the money is not considered income, it won’t affect your Social Security and Medicare benefits. Additionally, you will not have to pay any taxes on the money you receive from a reverse mortgage loan. However, you may still owe capital gains taxes when the home is sold after you move out.
No monthly mortgage payments
With a reverse mortgage, you do not need to make any payments to your new lender for as long as you remain in the home.
You can live in your house for the rest of your life
Many seniors worry about leaving their homes before they're ready. Reverse mortgages provide access to your home equity without you having to move or make additional monthly payments. Additionally, since it is a nonrecourse loan, the loan balance will never exceed the value of your home. This means that you (or your heirs) are not responsible for any amount of the loan that exceeds the value of your home when it is sold.
Cancel without penalty
Borrowers have at least three business days to cancel a reverse mortgage for any reason without incurring a penalty. If you've decided that this loan isn't good for you or an advisor recommends against it, you can cancel it in writing.
Cons of reverse mortgages
A reverse mortgage can seem like a miracle cure for your finances, but there are drawbacks to these loans. Some borrowers sign up for a reverse mortgage without understanding how it differs from a traditional mortgage.
You cannot tap into the full value of your equity
Your age, current interest rates and your home's appraised value determine the maximum loan you can get. Additionally, there is a maximum reverse mortgage amount on government-backed loans that changes annually. As a general rule, the older you are, the more you can withdraw through a reverse mortgage.
Reverse mortgage fees are substantial
With the most common type of reverse mortgage, a government-backed home equity conversion mortgage, (HECM), you'll pay up to $6,000 in origination fees plus an FHA mortgage insurance premium, third-party charges and servicing fees.
You still pay taxes and insurance
While a reverse mortgage eliminates your mortgage payments, borrowers are still responsible for paying property taxes and insurance payments yearly. Homeowners must also pay for utilities, repairs, maintenance and other costs of the home.
Interest rates may change on your loan
Most reverse mortgages have a variable interest rate, which can impact the amount of interest charged each month. Additionally, reverse mortgage interest is not tax-deductible until you make payments or pay off the loan.
The loan must be repaid if you die or move out
Borrowers must repay a reverse mortgage when they move out of the home. This is true even if the borrower moves into an assisted living or hospice care facility.
If your spouse or partner is not a signer on the loan, they may have to sell the property to repay the loan if you move out or pass away. Some lenders allow them to continue living in the home as long as they care for the property, but the reverse mortgage stream of income stops.
It impacts estate planning
The payments received, the interest charged and loan costs reduce the value of the estate that you pass on to your heirs.
"A reverse mortgage is always nonrecourse, meaning that if you are ever 'underwater' (you owe more than the value of the home) the lender cannot call the loan, nor if you pass away or decide to sell can they come after you (or the estate) for a deficiency judgment," said Fleming.
While this means your heirs aren’t going to owe when you pass, it can also mean that they will not be able to afford to repay the loan and must sell it.
» MORE: Reverse mortgage scams
Who is a reverse mortgage good for?
You might be a good candidate for a reverse mortgage if you fit some of the following criteria:
- Are 62 years or older
- Have significant home equity
- Plan to stay in your home
- Need supplemental income
- Want to defer Social Security benefits
- Don't plan to leave your home to heirs
If you meet the criteria for a reverse mortgage but still are unsure if it's the right move for you, pursuing reverse mortgage counseling could be beneficial. This counseling is designed to educate homeowners about the financial responsibilities involved, as well as potential risks and benefits associated with a reverse mortgage.
FAQ
How do I qualify for a reverse mortgage?
To qualify for a reverse mortgage, you must be at least 62 years old, live in the home as your primary residence, have no mortgage or have paid off most of your mortgage, and be able to cover recurring expenses, like property taxes and insurance. Borrowers must be current on federal debt and participate in an information session with an approved counselor for a HECM.
What are my payment plan options with a reverse mortgage?
Borrowers can receive a lump sum, line of credit or a stream of income payments from their reverse mortgage. The stream of income can last for as long as you live in the property or for a specified timeframe. Reverse mortgages do not require loan payments for as long as you live in the home.
How does the interest work on a reverse mortgage?
Interest charges on your reverse mortgage are added to your outstanding balance each month. Your mortgage balance continues to grow over time until you move out, sell the home or pass away. Interest charges are not tax deductible until you pay down your balance.
When is a reverse mortgage a good idea?
A reverse mortgage can be a good idea for seniors who need access to additional cash but don't want another monthly bill. This loan product is ideal for senior homeowners with a large amount of equity and who are not concerned with leaving their home to their heirs as part of their estate. These loans can meet the needs of various borrowers because you can get a lump sum of cash, a stream of payments or a line of credit to access as you need it.
Bottom line
A reverse mortgage can provide a financial lifeline for seniors with equity in their homes. This type of loan offers access to home equity without requiring the homeowner to sell the property or make monthly payments.
While these home loans can be a financial blessing, they can also be a curse in the wrong situations. Seniors must understand that the loan balance increases each month, and there are important ramifications for estate planning. Seek advice from a financial counselor or debt-management organization before signing on the dotted line.
Article sources
- U.S. Department of Housing and Urban Development, "How the HECM Program Works." Accessed Nov. 14, 2023.
- Federal Trade Commission, "Reverse Mortgages." Accessed Nov. 14, 2023.
- Consumer Financial Protection Bureau, "What happens if my reverse mortgage loan balance grows larger than the value of my home?" Accessed Nov. 14, 2023.
