Reverse mortgages are potent financial tools that should be used by the right people for the right reasons. They can offer wonderful advantages as well as difficult trade-offs. Weigh these realities when considering a reverse loan.
Advantages of Reverse Mortgages
Qualifying is easy: Because you don’t have to make monthly payments to a lender, your credit rating is much less important. Reverse mortgages are the only home loan products that don’t include higher interest rates and fees for people with bad credit, and because you don’t make monthly payments, income is not as crucial either. However, the lender is required to complete a financial assessment for government-backed reverse mortgages (HECMs). Its purpose is to make sure that you’ll be able to pay your property taxes and homeowners insurance premiums, and stay out of foreclosure. If the lender believes you might have difficulty with this, it may choose to withhold some of your loan proceeds and pay these things for you.
Proceeds are not taxed as Income: You can increase your cash flow without incurring income taxes. If, for example, you take on a part-time job for extra money, and your tax bracket is 25 percent, you have to earn more than $2,600 to increase your spending money by $2,000. A $2,000 monthly payment from your reverse mortgage actually puts $2,000 in your pocket.
Your equity remains yours: Some people think that taking out a reverse mortgage means you no longer own your home. That’s not true. In fact, if you sell your home, any extra equity once your loan is repaid comes right back to you. If you remain in your house for the rest of your life, the extra equity is returned to your estate. Your heirs can also choose to pay the loan off instead of selling the property.
You can use a reverse mortgage to avoid foreclosure: Those with home equity but not enough income to pay a mortgage can retire their home loans with reverse mortgages—getting rid of their mortgage payments.
You can’t outlive your loan: If you choose monthly payments for life (tenure), you can’t outlive your loan. You’ll continue to receive monthly payments as long as you reside on the property. If your balance exceeds your property value when you move or die, you aren’t responsible for repaying the difference.
You can use your reverse mortgage for any purpose: Whether you want monthly income to stretch your retirement benefits, a lump sum to get rid of debt or a smaller amount for a world cruise, it’s your business. You can even use a reverse mortgage to buy a new home without mortgage payments.
Tradeoffs of Reverse Mortgages
There are occupancy requirements: You must live in the home. Seniors emerging from stints in hospitals or nursing homes (generally longer than 12 months) have found themselves in foreclosure. Also, don’t take out a reverse mortgage if your plans include a two-year round-the-world excursion – if you’re away for more than a few months, you could lose your home. Lenders are required to verify your occupancy every year.
Maintenance and taxes are still required: If your home’s value is compromised by poor maintenance, the lender could foreclose. If you fail to pay your property taxes or insurance, you could lose your home to foreclosure.
Reverse mortgages can be an expensive way to borrow: Many reverse mortgage fees are calculated as percentages of the home’s value, not the amount borrowed. For this reason, they can be more expensive than home equity loans if you only want to borrow a small amount. If you can qualify to borrow with a home equity loan (which requires monthly payments), it’s probably a better way to go.
You can lose eligibility for Medicaid or Supplemental Security: If you take your reverse mortgage proceeds as a lump sum, and don’t spend it immediately, you could lose eligibility for needs-based programs. In most cases, a single person is only allowed to have $2,000 in cash to be eligible for Medicaid.
You can see that some of these pros and cons can be difficult to navigate. For this reason, advocates like Consumers Union recommend that you get reverse mortgage counseling, shop carefully for the best reverse mortgage deal, and avoid signing anything that you don’t understand. For more information, check out the article Understanding Reverse Mortgage Disclosures on these pages.