Most older adults hope to live in the place they know and love for as long as possible—their own homes. Home equity is typically one of the biggest slices of the net worth of older-adult homeowners—and the strategic use of home equity can be a great option for mature homeowners who are looking to bolster their retirement cash flow strategies.
A reverse mortgage could help you to effectively leverage your home’s equity without having to sell your home. We want you to understand the pros and cons of a reverse mortgage to help you decide if one may be right for you (or a loved one).
What is a reverse mortgage, and how does it work?
A reverse mortgage is a loan for older-adult homeowners that allows the borrower to convert a portion of the home’s equity into cash and defer repayment until a later date. As long as you, as the borrower, continue to meet all of the terms of the loan, the loan balance only becomes due when your home is no longer your primary residence (e.g., you permanently move out of the home or pass away). The loan is then typically satisfied through the sale of the home.
Most but not all reverse mortgages are Home Equity Conversion Mortgages (or HECMs), the only reverse mortgages insured by the U.S. Federal Government. HECMs are specifically designed for homeowners who are 62 and older, and only available through FHA-approved lenders. This article refers only to HECM reverse mortgages.
One of the basic eligibility criteria to qualify for a reverse mortgage is that you own your home outright or have significant equity in your home. Generally, the more your home is worth, and the less you owe on your home, and the lower the interest rate on your loan, and the older you are—the greater your initial borrowing limit will be.
What are the pros and cons of a reverse mortgage?
- You are not obligated to make a monthly mortgage payment—although you can—for as long as you meet the loan terms, which require you to live in your home as your primary residence and pay property-related taxes, insurance, and upkeep expenses.
- You can access a portion of your home’s equity without incurring income tax*
- You are able to receive payments in several different ways: a single, lump sum disbursement; a line of credit to draw from as needed; or steady fixed monthly advances (either for a set number of months or for the life of the loan)
- The loan proceeds can be used for just about any purpose. Common uses are to supplement monthly income, establish an emergency fund, refinance an existing mortgage, and pay for in-home care or home renovations.
- You can age in a familiar home without having to sell it in order to access the equity
- You retain the title to your home until you pass away, sell the home, move, or reach the end of the loan terms. As the homeowner, you can remodel your home or even sell it at any time—just like you could if you had a traditional forward mortgage.
- A reverse mortgage generally does not affect Social Security or Medicare benefits
- A reverse mortgage is a non-recourse loan. That means neither you nor your heirs will ever owe more than the home worth when a maturity event occurs (e.g., if you were to permanently move out of the home, which then made the loan due and payable) and your home is sold to satisfy the loan.**
- So, if the sales price of the home is less than the balance on your loan, you or your heirs are not responsible for paying the difference. (Conversely, if the home sells for more than the loan balance, you or your heirs would keep the difference.) The loan’s non-recourse benefit is insured by the FHA.
- Almost all of the upfront costs, including reverse mortgage closing costs and ongoing fees, can be rolled into the reverse mortgage. One exception is the HECM counseling fee, which has to be paid from your own funds and is typically around $125.
- You can access a growing line of credit on any unused funds. The unused portion of the line of credit will grow each month at the same compounding rate as the loan balance—giving you access to even more funds in retirement.
- Reverse mortgages tend to be easier for older-adult homeowners to qualify for compared to a traditional mortgage, home equity loan, or home equity line of credit.*** (There is no minimum credit score requirement and the income requirements are less stringent.)
Reverse mortgage cons
- The unpaid reverse mortgage loan balance grows over time. This is because interest and fees get tacked to the unpaid loan balance. Note: You do have the option to pay down the loan balance at any time—you can pay as much or as little toward it as you would like.
- You are drawing down on your home equity. Naturally, that likely means your heirs would have less money (or no money at all) coming to them from that particular asset. However, by strategically tapping home equity first, you may be able to extend the life of your other productive assets—which could potentially lead to you having greater net worth to leave to your family.*
- Your eligibility to qualify for needs-based programs—such as Medicaid—may be affected.
The upfront costs tend to be higher for a reverse mortgage than a traditional mortgage or other type of home equity loan.
- A reverse mortgage must be in the first lien position. Any existing mortgage on your home must be paid off in full prior to establishing a reverse mortgage. Note: A borrower can apply proceeds from the reverse mortgage to pay off an existing mortgage at closing.
- With a reverse mortgage, you must meet your loan obligations to avoid triggering a maturity event, which would make the loan due and payable. Your loan obligations include occupying the home as your primary residence and paying your property taxes, homeowners insurance, upkeep expenses, and HOA fees (if applicable).