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- When you get a reverse mortgage, instead of making a monthly mortgage payment, the lender pays you.
- The benefits of a reverse mortgage include increased cash flow in retirement and the ability to age in place.
- But reverse mortgages can ultimately be expensive and complicate your ability to pass the home on to your heirs.
A reverse mortgage is a type of mortgage that lets you take equity out of your home. To get one, you have to be at least 62 years old and either own your home outright or have a low balance on your current mortgage.
Reverse mortgages can be useful tools for seniors who want to stay in their homes and turn their home equity into cash they can use each month. But depending on your goals, there can be some pretty significant drawbacks to these types of mortgages.
How do reverse mortgages work?
When you get a reverse mortgage, instead of paying a mortgage bill each month, the lender pays you. You can receive your reverse mortgage funds in the form of monthly payments, a lump sum, or a line of credit. The money you get comes out of your home, turning your equity into cash.
Once you sell your home, move out, or die, the loan will need to be repaid — typically out of your estate or using the proceeds from the home sale.
The most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM), which is insured by the US Department of Housing and Urban Development (HUD).
Remember that a reverse mortgage is a loan, meaning you won't receive the funds from it for free. Lenders charge interest and fees on reverse mortgages. Often, these mortgages can be more expensive than other home loans, according to the Consumer Financial Protection Bureau.
Pros and cons of reverse mortgages
Pros
- More cash in retirement. Payments from a reverse mortgage can be useful if your retirement savings and Social Security checks just aren't cutting it. If an extra source of income would help ease your budget worries or make your retirement more comfortable, a reverse mortgage could be worth it.
- You don't have to make monthly payments. Unlike other types of loans that let you tap into your home's equity, you don't have to make monthly payments on a reverse mortgage. Instead, you or your estate will owe the full balance when you sell, move out, or die.
- You won't need to pay back more than what the home is worth. If your home depreciates significantly in value, you could end up having a higher balance on your reverse mortgage than what your home is worth. If this happens, lenders can't go after your assets for the remaining balance. So for example, if you borrow a total of $200,000 on a home that ends up selling for $180,000, you won't owe the $20,000 difference. With a reverse mortgage, you'll only owe what your home is worth at the time the loan becomes due.
- It allows you to stay in your home. Using the money in your home to pay off your existing mortgage, eliminate your monthly mortgage payment, and supplement your income makes it much easier for you to remain in your home and age in place.
- It's tax-free money. Funds you receive from your reverse mortgage aren't considered income, so you won't pay taxes on them. This is in contrast with many of the other sources of income seniors rely on in retirement, such as traditional IRAs and 401(k)s.
"While it may seem like you are earning 'income' from the mortgage, the IRS does not view it that way," says Levon L. Galstyan, a certified public accountant at Oak View Law Group. "You won't owe more taxes on April 15 since reverse mortgage payments are treated as loan proceeds, not taxable income."
Cons
- You need to have enough equity. To qualify for a reverse mortgage, you'll need to either own your home outright (meaning you don't have a mortgage on the property) or have paid down a "considerable amount," according to HUD. Expect lenders to require at least 50% equity.
- You'll still pay closing costs and mortgage insurance. You may pay origination fees up to $6,000, a mortgage insurance premium, and other closing costs (such as an appraisal, title search, or other fees).
- You'll pay interest and fees over the life of the loan. In addition to upfront costs, you'll also be charged interest on your balance, an annual mortgage insurance premium, and any servicing fees your lender charges. You'll also still have to pay other non-mortgage housing costs, such as homeowners insurance, property taxes, and homeowners association dues.
- Non-borrowing spouses won't continue receiving money after you die (though they may be able to remain in the home). If your spouse isn't on the reverse mortgage and you die or move into a long-term healthcare facility, they won't be eligible to continue receiving funds. However, they may be able to remain in the home and have the repayment of the mortgage deferred if they meet HUD guidelines.
- Your heirs will have to pay off the loan if they want to keep the home. For some homeowners, passing their property along to their heirs after they die is important, and getting a reverse mortgage complicates that. If your heirs want to keep the home, they'll need another source of funds to pay off the mortgage.
Alternatives to a reverse mortgage
If you're in need of extra funds but a reverse mortgage doesn't make sense for your situation, you might instead try:
- A home equity loan or home equity line of credit. These types of home loans let you take equity out of your home and use the funds however you like, similar to a reverse mortgage. These loans can be good if for those who have a specific project or goal in mind for the money they're taking out — such as making modifications or upgrades to the home. Plus, a home equity loan or HELOC lender may be able to offer you a better rate than you'd get with another type of loan, such as a personal loan.
- Refinancing your current mortgage. Refinancing replaces your existing mortgage with a new one. A traditional rate-and-term refinance can help lower your monthly payment if you're able to snag a lower rate or lengthen your loan term. A cash-out refinance turns a portion of your equity into cash that you'll get at closing. Refinancing can give you more wiggle room in your monthly budget or help you pay for a big expense, but do the math to be sure it actually makes sense for your situation. If you do decide to refinance, make sure to shop around with multiple mortgage refinance lenders — you don't necessarily need to go with the lender you have your current mortgage with.
- Downsizing. If you're having trouble affording your current housing costs, you might consider moving into a smaller, more affordable home.
Reverse mortgage pros and cons frequently asked questions
Who benefits most from a reverse mortgage?
Older homeowners who want to supplement their retirement income might benefit from a reverse mortgage.
Are reverse mortgages really worth it?
Reverse mortgages can be worth it if you're looking to add to your income in retirement, but your decision to get one should fit into a larger financial plan that suits your needs and goals. It's also important to first think about your long-term plan for your home, since these mortgages are typically paid back using the proceeds from the sale of the home.
Is there monthly interest on a reverse mortgage?
Yes, you'll be charged interest each month on your reverse mortgage loan balance. But the payment of your loan balance plus interest isn't due until you either leave the home or die.