Homeowners

The Pros and Cons of Reverse Mortgages for Older Homeowners

Many older homeowners are house-rich but cash-poor. After decades of making mortgage payments, they may have built substantial home equity or even paid off their homes entirely. But that wealth is tied up in their property.

A reverse mortgage loan offers a way that homeowners can put that equity to use without selling their properties or moving out.

“For some retirees, especially those with limited liquid savings but a strong emotional attachment to their home, a reverse mortgage can buy time and relieve financial pressure,” said Melissa Caro, a certified financial planner and founder of My Retirement Network.

Reverse loans may provide a lifeline for cash-strapped older adults and their heirs may be able to keep the homes if they can’t pay off the loan balance.

But before embarking on this path, make sure you understand the loan and consider the pros and cons of a reverse mortgage.

What is a reverse mortgage?

A reverse mortgage is a loan that allows eligible homeowners age 62 and older to turn part of their home equity into cash without making monthly mortgage payments. Instead, the borrower receives payments from the lender, typically monthly, in a lump sum, or through a line of credit.

The loan becomes due when the borrower permanently leaves the home, sells the property, or passes away.

There are different types of reverse mortgages, but the most common type is the Home Equity Conversion Mortgage (HECM). The HECM is the only government-insured reverse mortgage, and you can get one through a Federal Housing Administration (FHA) approved lender.

To qualify, the youngest borrower on the loan must be 62 or older. Your home must also be your principal residence. You must also have enough equity in the property, typically about 50% to 60%, and meet certain FHA financial and property rules.

The pros of a reverse mortgage loan

A reverse mortgage loan holds many advantages that could ease financial pressure in retirement, such as:

• The money isn’t considered income. The cash you receive from a reverse mortgage is generally not treated as income for tax purposes. That means it shouldn’t bump you into a higher tax bracket or affect how your Social Security benefits are taxed.
• You can access funds in several ways. Your three primary distribution options are a lump sum payout, monthly payments, a line of credit, or a combination of options.
• You can stay in your home. The home remains yours, and you can keep living in it as long as it stays your primary residence and you keep up with property taxes, insurance costs, and maintenance of the property.
• You can never owe more than the home is worth. This is important for homeowners and their heirs to note.

“All reverse mortgages are non-recourse, meaning the home is the only asset that can be attached to the debt,” said Larry Melton, an Oregon-based retirement loan specialist at New American Funding. “If there is a shortfall, FHA covers that amount and pays it directly to the lender.”

The cons of a reverse mortgage

A reverse mortgage loan can provide older homeowners with much-needed cash flow to ease financial pressure, but there are some downsides to consider before proceeding.

• You must meet eligibility requirements. Reverse mortgages come with rules to protect both borrowers and lenders. You need to be 62 or older, use the home as your primary residence, have substantial equity, and complete a counseling session with a U.S. Housing and Urban Development (HUD) approved counselor.

Borrowers also go through a financial assessment to confirm they can meet the ongoing financial requirements.

• You still have ongoing housing obligations. You still need to pay property taxes, homeowners insurance, and home maintenance and repair costs. If you can’t keep up with these expenses, you could risk losing the home to foreclosure.

“A reverse mortgage does not eliminate the cost of owning a home,” said Caro.

• The reverse loan balance grows over time. Unlike a traditional mortgage, where the balance decreases as you pay it down, a reverse mortgage works the other way. Interest accrues on what you’ve borrowed, and the balance gets larger each month.
• A reverse mortgage becomes due when you move. If your physical health changes and you move in with loved ones or into an assisted living facility, you need to pay back your loan. This is something homeowners want to consider before taking out one of these loans.
• A reverse mortgage could impact your heirs. When the borrower sells, moves out, or passes away, the loan comes due. Heirs typically have six months to settle the loan (with possible extensions up to one year) by selling, refinancing into a different loan, or paying off the balance in cash.

If they choose to sell, any money left over after the loan is repaid belongs to them.

Is a reverse mortgage a good idea?

As with many financial decisions, whether a reverse mortgage is a good idea will depend on your financial goals and long-term plans. It may be a good fit if you plan to live in your home for years and need a way to inject additional cash flow into your retirement.

It may not make sense, though, if you will still struggle to keep up with required costs, such as property taxes, homeowners insurance, and maintenance and repairs.

Talking with a HUD-approved counselor or a financial advisor may help you decide whether a reverse mortgage is right for you.