Get to Know the Pros and Cons of a Reverse Mortgage
There’s a good chance you’ve heard of a reverse mortgage. The idea behind it is simple—rather than getting a home loan and making payments to the lender, the lender makes payments to you. These payments can either be a lump sum or a monthly payment. Either way, loan repayment is not required until you pass on or move our of the house.
Even though a reverse mortgage feels like free money, it’s actually a loan. Interest, service fees, and mortgage insurance will all be assessed and added to the loan balance. Over time, those costs can add up significantly.
Even if it sounds like a good deal for you, the reality is that reverse mortgages are controversial. Some hail the reverse mortgage as a sensible solution for retirees who need extra money, allowing them to tap into what is likely their most valuable asset.
On the other hand, though, critics point out that reverse mortgages often come with high fees, and loan balances increase over time. Additionally, reverse mortgages that aren’t made through an FHA program may lack some consumer protections, which could leave you (or your heirs) on the hook if the home loses value.
Before you make a decision, here’s what you need to know about reverse mortgage pros and cons.
Potential to receive regular income as long as you occupy the home as your primary residence.
Payments from a reverse mortgage aren’t considered taxable income.
FHA reverse mortgage loans are non-recourse, so you can’t owe more than the current value of the property.
Payments don’t need to be made on the loan until the borrower moves, sells or dies.
You must be at least 62 (or the youngest person in a couple must be this age) in order to get a reverse mortgage through the FHA program.
There are several costs to getting a reverse mortgage, including mortgage insurance.
Your heirs may not be able to keep the home if they can’t afford to pay off the loan.
If you are unable to remain in the home due to long-term care needs, the loan becomes due.
Requirements of a Reverse Mortgage
A reverse mortgage is generally a type of FHA loan, called a HECM loan, While some lenders offer proprietary (or non-FHA insured) reverse mortgages, most of these loans are offered by lenders who use the HECM program through the FHA. When considering a reverse mortgage, consider focusing on programs that are FHA-insured and must adhere to federal guidelines. With non-HECM reverse mortgages, you could lose important consumer protections, and you won’t be guaranteed the uniform requirements provided by the FHA.
In order to qualify for a reverse mortgage, the following must apply:
- Be at least 62 years of age
- Live in the home as a primary residence
- Not be delinquent on federal debt
- Be able to keep paying taxes, insurance, and other costs
- The property must meet FHA requirements
You can choose to receive your payments as long as you are alive and live in the home, or you can set up a set term to receive payments. It’s even possible to use a line of credit for your reverse mortgage. No matter what type of payment setup you choose, you can’t be forced to sell your home to pay off the mortgage, and you won’t have to make payments until you no longer live in the home.
Given this information, it might seem like a reverse mortgage is a slam dunk, and there are situations in which a reverse mortgage makes sense. However, there are some drawbacks to reverse mortgages that can cause financial harm to some retirees.
Reverse Mortgage Pros
Here's a look at some of the upsides of a reverse mortgage.
You'll Have Regular Income During Retirement
As long as you remain in the home, using it as your primary residence, you can receive regular income during retirement. For some retirees, who struggle to meet their living expenses, this can be a big help.
How much you can borrow to meet these expenses depends on the age of the youngest borrower, current interest rate, and the value of the home. How much equity you have in the home is considered if you have only “paid-down a considerable amount” rather than owning the home outright, according to the FHA.
With a reverse mortgage in place, you can choose to receive equal payments for the remainder of your life—or as long as you live in the home. Alternatively, you can decide to get those payments for a set period—running the risk that you’ll outlive the payments and not have enough income.
There are also payment arrangements that include a line of credit, allowing you to take the money as needed.
However you decide to do it, though, the bottom line is that you end up with access to income during retirement, which can supplement your other retirement resources.
You Won’t Pay Taxes on the Money You Receive
When you’re working out how to manage retirement income in a tax-efficient manner, a reverse mortgage can help. You won’t have to pay taxes on the money you receive in payments from the lender.
On top of that, because the IRS considers a reverse mortgage a loan, and not actual income, it also won’t be counted in formulas that use your income, such as impacts to your Social Security and Medicare benefits.
It's a Non-Recourse Loan
One of the biggest worries associated with a reverse mortgage is what happens if the home loses value. Could you be on the hook for extra if the home doesn’t sell for what you owe?
FHA mortgage insurance covers any difference between the sales price of the home and what you owe—as long as the home sells for 95% of its appraised value. So, even if your home sells for less than you owe, you don’t have to worry about it as long as the sales price is within the government's boundaries.
As long as your home is insured by the FHA, you won’t be forced to repay more than the price of the home. You’ll have to sell your home to cover your obligation if you move out of it, but you won’t be stuck with a huge bill.
You Can’t Be Forced Into Early Repayment
Repayment of the reverse mortgage will be triggered when one of the following circumstances applies: 1) the home is no longer your primary residence; 2) you sell the home; or 3) you die.
When you sell the home, you’re expected to use the proceeds to pay off your remaining loan balance. However, if the home sells for more than you owe, you can keep the difference and use it for something else.
While you won’t have to make monthly loan payments, you will likely have to make monthly payments to cover property taxes and insurance and take care of ongoing maintenance costs.
If you die, your heirs might have to repay the loan. For those whose estates can’t afford the loan, heirs might be required to sell the home to get the proceeds necessary. Luckily, though, they won’t be expected to pay more than the home’s current market value, so they aren’t on the hook if the home has lost value.
Reverse Mortgage Cons
The ability to tap into your home's equity can help pay for retirement, but there are some negatives.
You Must Be at Least 62
If you want a reverse mortgage insured through the FHA, the youngest borrower needs to be 62. For those with younger spouses, this can derail the reverse mortgage process.
There are ways to get around this, such as deeding the home to the older spouse and leaving the non-qualifying partner off the reverse mortgage, but this strategy might cause issues later. In general, if both spouses don’t qualify for an FHA-insured reverse mortgage, it might make sense to wait until both meet the requirement.
With a non-FHA-insured reverse mortgage, lender terms might be different, and might not offer as much protection.
There Are Several Costs
You could be subject to several costs when you decide to get a reverse mortgage. Some of the fees that come with a reverse mortgage include:
- Mortgage insurance: An initial premium of 2% of the loan amount, plus 0.5% of the annual outstanding loan balance each year.
- Closing costs: You might be stuck with these third-party charges, depending on the lender you use, and they vary.
- Origination fees: Lenders can charge up to $6,000 in origination fees, based on your home’s value.
- Servicing fees: The FHA allows lenders to charge monthly servicing fees.
All of these fees can be included in your loan, but they will reduce the amount you receive.
Your Heirs Might Not Be Able to Keep the Home
If you want to pass your home on to your children or other heirs, it might not be possible if your estate doesn’t have enough in assets to pay off the loan.
Once you die, the loan becomes due. If your heirs can’t figure out a way to pay off the loan using other resources, they’ll have to sell it instead of keeping it. Before getting a reverse mortgage, double-check that you have a way for your estate or life insurance to pay off the debt if keeping the home in the family is an important priority.
Your Loan Is Due If You Move Into Long-Term Care
You can live in your home as long as you like, without making a payment. However, if you don’t live in the home for the majority of the year—or if you’re out of the home for more than 12 consecutive months due to a medical issue—your loan could come due. At that point, you either need to sell off the house or use other funds to pay off the loan.
Moving into a long-term care facility or a nursing home counts as no longer using your home as a primary residence. If you’re in a nursing home or other care facility for 12 consecutive months, your loan becomes due.
You Can Still Lose Your Home to Foreclosure
When you don’t meet these requirements, your home can be foreclosed. It’s important to make sure you have money available to make these payments or risk losing your home. Some lenders will create a “set aside” account to help you deal with these costs, funneling a portion of your loan into the account. However, a set-aside account isn’t a guarantee that you’ll always have the money for these costs. Pay attention and be sure you’re up-to-date.
In the end, a reverse mortgage is like any other financial tool. You need to understand how it works and how it might fit into your finances to decide if it’s right for you.