What Is a Reverse Mortgage and How Does It Work?
A reverse mortgage is a loan that seniors over the age of 62 can use to help provide financial assistance in their retirement years. In uncertain economic times, a reverse mortgage can offer an alternative funding source for retirement.
This kind of mortgage helps homeowners with considerable home equity (one report suggests that seniors are sitting on $7 trillion in housing wealth) convert that equity to income.
A reverse mortgage is the opposite of a traditional loan, in which a homebuyer uses a mortgage to purchase a home by making monthly payments. Taking out a reverse mortgage does not require the homeowner to make any monthly payments.
However, a reverse mortgage isn’t free money either. It’s still considered borrowed funds. Once the equity is used, the homeowner is required to repay it. The funds don’t need to be repaid until the homeowner leaves the home, usually by selling the house.
Also, homeowners with a reverse mortgage still need to pay property taxes and homeowners insurance.
How does a reverse mortgage work?
When a homeowner decides to take out a reverse mortgage, the lender makes payments to the borrower. The homeowner has different options of how to receive monthly payments and needs to pay interest on the funds. The title is still kept under the homeowner’s name.
Over the life of the loan, the homeowner’s debt goes up while the home’s equity decreases. Because of this, there are some home experts who advise against taking out this kind of loan.
Why do seniors take out reverse mortgages?
Specifically, Baby Boomers are tapping into their homes to help with their financial situation in retirement. Almost 10,000 Baby Boomers turn 65 every day in the U.S., and many are concerned they won’t have enough for retirement.
Seniors need to think about the rising cost of healthcare and how they will continue to pay for day-to-day living expenses, in addition to planning out things like property taxes.
Some may simply not have saved enough or planned their retirement income properly and therefore expect to outlive their retirement income. Also, people today are living longer due to a greater awareness of a healthy diet and exercise.
Pros of a reverse mortgage
The biggest advantage of a reverse mortgage is probably the fact that you wouldn’t have to deal with a monthly mortgage payment or make any payments towards interest.
Here are more potential benefits of taking out a reverse mortgage.
- You can continue to live in your house and still have your name listed on the title.
- You can have steady income if money is tight or you don’t have another means of income in retirement.
- There are a variety of options for how you can receive your monthly funds. One can be for a set period of time, as needed, or as long as you live in the home. Or it can be a combination of all of them.
- The loan doesn’t need to be paid back until you decide to sell the house, move out, or pass away.
- If the value of the property goes down, you can still use up to the original loan amount, even if it’s more than the home’s current value.
- When you repay the loan and the loan balance is smaller than the value of the home, you get to keep the difference.
Cons of a reverse mortgage
The term “house rich and cash poor” has often been used when the topic of a reverse mortgage is brought up.
Some financial experts strongly advise against cash-strapped seniors taking out reverse mortgages. Consumer Reports cautions, “Reverse mortgage should only be a last resort for seniors who want to stay in their homes and have no other alternatives.”
The biggest disadvantage in a reverse mortgage is that it can end up costing a lot. Just like any loan you take out from the bank, the fees and closing costs may be high. You still have to pay insurance, property taxes, homeowners association fees, and costs to keep the home in good condition.
Beyond that, there are other factors to consider — including a homeowner’s heirs and who lives in the home.
“Heirs may not be able to inherit a home that is under a reverse mortgage,”explains SelFi senior mortgage advisor Erica Zepko. “If the homeowner has to move into long-term care due to illness, the loan may become due because the homeowner isn’t living in the house. Also, when the senior dies, sells the home, or moves, the loan immediately comes due. That means anyone who lives in the house — friends, relatives, boarders — may be forced out.”
Read more: Should I Sell My House to Fund My Business?
Here are more cons to think about for reverse mortgages:
- The balance of the loan increases as interest accrues.
- You lose equity in the home over time.
- A reverse mortgage may affect your eligibility for government programs such as Medicaid or Supplemental Security Income (SSI).
Alternatives to a reverse mortgage
There are many options outside of a reverse mortgage that can be an alternative to a homeowner looking to use their house to raise money. Here are three common alternatives:
1. Refinance your home
At the time of writing, mortgage rates were near historical lows, so you could potentially refinance your home to reduce the monthly amount you’re paying. Some refinances allow you to access cash.
Check current rates online and compare a refinance to what it would cost if you took out a reverse mortgage.
After making the calculation, you may discover that you can free up enough extra cash each month from the lower refinanced payment so you don’t need to take out the reverse mortgage.
2. Take out a HELOC
A HELOC, or Home Equity Line of Credit, also allows you to tap into your home’s equity. These loans are generally used to make home improvements, but can be used for anything.
A HELOC could be an option for seniors who need a cushion to cover unexpected expenses. It also makes sense for people who are averse to making increased payments in the future.
Here are more benefits to HELOCs:
- The fees and interest rates are likely lower than a reverse mortgage.
- You may withdraw money as you need it.
- During the draw period, you can choose to make interest-only payments or payments of principal and interest.
- Interest paid often is tax-deductible. The IRS explains the rules on its website.
Keep in mind that taking out a HELOC means you’d have to make additional monthly payments. If you can’t, you risk foreclosure, so make sure you will be able to cover monthly payments if you decide to take out a HELOC.
3. Sell your home and downsize
Many seniors are empty nesters and may not need all the space anymore. Selling your home could be a less expensive way to downsize to a smaller, less expensive place. You may be able to find a similar space with lower monthly expenses by renting.
Learn more: Should I Buy or Rent?
Sundae offers a seamless way for sellers to quickly sell their home for cash at a great price. This solution is especially attractive if you don’t have a lot of time to put your home on the market and wait for a buyer.
Taking out a reverse mortgage can help seniors who are concerned about their income in retirement. If you or a loved one is thinking about taking this route, make sure to do your proper research and speak to a professional about your specific financial situation.