Reverse mortgage pros and cons

If you are a homeowner, you have likely heard or seen TV commercials about reverse mortgages,  or even considered taking this type of mortgage. However, each financial product is two-sided, and you should weigh the pros and cons of a reverse mortgage before signing off the mortgage documents. 

When you get approved for a reverse mortgage, you will receive payments from the lender and still keep your home. The payments you receive are considered "loan proceeds", and therefore, not taxable. You can use the loan proceeds to pay off your existing mortgage loan, pay healthcare costs, or finance home repairs. On the downside, a reverse mortgage is not cheap, and you will pay several fees, including interest, insurance, origination fees, and closing costs. If you are unable to keep up with the cost of owning your home such as property taxes and homeowner insurance, you risk losing your home to foreclosure.

What is a reverse mortgage?

A reverse mortgage is a type of mortgage that allows homeowners 62 or older to borrow money against the equity in their home. If you qualify for a reverse mortgage, you will receive payments from the lender either as a lump sum, payment plan, or a line of credit, and the loan won’t be due until when you sell the home, move out, or die.

Reverse mortgages can provide a financial lifeline for seniors who want to remain in their homes but don’t have enough income to keep up with the cost of owning a home. Borrowers can receive loan proceeds either as a lump sum payment, payment plan, or a line of credit.

How does a reverse mortgage work?

When you take a reverse mortgage, you can use the loan proceeds for any purpose, including paying off an existing mortgage, supplementing retirement income, and paying for home repairs or upgrades.

To be eligible for a reverse mortgage, you must fully own the home, or have at least 50% equity in your home. The home must be your primary residence, and you should have sufficient income and assets to continue paying property taxes, homeowners insurance, and other financial obligations related to the property.

Reverse mortgages are available as either fixed-rate or variable-rate loans. Fixed-rate loans offer predictable monthly payments, while variable-rate loans may have lower initial payments but could increase in later years.

Pros of a reverse mortgage

If you have built a lot of equity in your home but you are running out of your retirement income, a reverse mortgage can help you boost your income.

Here are the advantages of taking a reverse mortgage:

You don’t have to move from your home

Instead of selling your home to get money, a reverse mortgage can give you a lump sum payment and still keep the property. You can use the lump sum payment to pay the balance on your existing mortgage, pay healthcare expenses, or make a large purchase. You won’t be required to make payments until when you sell the home, move out, or die.

You can get tax-free money

The money you receive from a reverse mortgage is considered a loan, and not an income, and this means it is not subject to income taxes, unlike other retirement distributions like 401(k) withdrawals, pensions, and Social Security income.

You can use the money for anything

When you take a home equity conversion mortgage or proprietary reverse mortgage, there is no restriction on how you can spend the money. You can spend the money on anything, including medical expenses, home renovations, home upgrades, or even travel. However, if you take a single-purpose reverse mortgage, you can only use the funds for the stated purpose.

Heirs have options

If you are an heir to a homeowner with a reverse mortgage, you have several options. You can choose to keep the home and pay the reverse mortgage from other sources, restructure the mortgage, or sell the home and keep the remaining equity. If the debt exceeds the value of the property, you will only owe what the property is worth when the loan becomes due.

Supplement retirement income

If you don’t have enough retirement income to pay your living expenses, and you have a lot of equity in your home, a reverse mortgage can provide liquid assets to help ease your budget worries. You won’t be required to make payments until when you sell your home or die.

A spouse can stay in the home after you die

If you were married at the time you took out the reverse mortgage, your spouse has a right to stay in the home after you move out or die. This applies even if the surviving spouse was not listed as a co-borrower on the loan documents.

Cons of a Reverse Mortgage

Although a reverse mortgage may have certain benefits, it can also present some risks to the homeowner. Here are some drawbacks of a reverse mortgage:

You reduce your heir’s inheritance

As the reverse equity balance grows, your home equity reduces gradually, and if you live for a long time, the home equity may be diminished. Your heirs may have no equity left to inherit, and they will be forced to sell your home to pay off the reverse mortgage.

Risk of foreclosure

When you take a reverse mortgage, you must be able to afford homeowner association fees, property taxes, homeowner insurance, and other costs associated with owning the property. If you are unable to pay these expenses, you will be considered to have defaulted on the reverse mortgage, and you could lose your home to foreclosure.

It can affect eligibility for need-based programs

If you take out a reverse mortgage, it can affect your eligibility for need-based programs, such as Medicaid or Supplemental Security Income (SSI). This is because the government considers the money you receive from a reverse mortgage as liquid assets. If you collect these benefits, you should ask about it during the counseling session with a HUD-approved counselor to make sure your eligibility for benefits is not compromised.  

High upfront fees

While you may not be required to pay monthly mortgage payments to the lender, there are plenty of upfront expenses associated with reverse mortgages. You are required to pay origination fees at closing, insurance premiums at 2% of the home’s appraised value, as well as keep up with property taxes, homeowner insurance, and homeowner association fees. You may also be required to pay monthly service fees of up to $35 to cover the cost of maintaining the loan.

No interest deduction

While a traditional mortgage allows borrowers to deduct the interest payments on their annual tax return, you won’t be able to deduct the mortgage interest each year. You will only be able to claim this tax benefit when the loan becomes due, usually when you sell the property, move out, or die.

Should you take a reverse mortgage?

If you are considering taking a reverse mortgage, there are several factors you should consider to determine if a reverse mortgage is worth it.

First, you should consider how long you plan to stay in your home. If you don't plan to relocate or move into a retirement community, taking a reverse mortgage can make the cost worth it. In this case, ensure you have enough assets and income to cover the costs of owning your home such as insurance and property taxes.

Additionally, if your home is increasing in value, it means you will have a lot of equity in your property. You can take a reverse mortgage against the home to get a lump sum payment for a big purchase, and still have some equity left for your heirs. However, if you live for a long time, there is a risk that the debt could exceed the accumulated equity, and you will have no equity left for your heirs.

Before taking a reverse mortgage, you should weigh your options to determine if it is worth it. While this type of mortgage can help supplement your retirement income, it can also put your finances at risk.