You’re retired, or about to be, with limited income and savings, but lots of equity in your home. It’s a familiar scenario. Many people in this position consider moving down or selling their home and renting—perhaps in a retirement community. Refinancing to take advantage of lower rates and/or take money out to pay off debts and have a cash cushion is another possible option. A reverse mortgage is another consideration, and one that offers a unique set of benefits—but also some potential downsides. We’re breaking down the pros and cons of this unique type of mortgage.
What is a reverse mortgage?
A reverse mortgage is a way to tap the equity in your home once you reach the age of 62 and eliminate your monthly mortgage payments—for now. “When you have a regular mortgage, you pay the lender every month to buy your home over time. In a reverse mortgage, you get a loan in which the lender pays you,” said the Federal Trade Commission (FTC). “Reverse mortgages take part of the equity in your home and convert it into payments to you—a kind of advance payment on your home equity.”
What are the advantages of a reverse mortgage?
First, you get to use the equity you’ve built up to supplement your monthly income, pay bills, go on vacation, or anything you need.
• “You get the money up front, but the interest is deferred until you move out,” said the FTC.
• The money is usually tax-free.
• You don’t have to pay it back until after you have moved out of your home.
Are there any disadvantages?
For starters, you won’t be living in the house Scot free. “Owners must pay the property taxes and insurance costs and keep the house in good condition when they agree to a reverse mortgage,” said Debt.org. “If they don’t—and many have fallen into that trap—the lender can foreclose.”
• There are fees. “Reverse mortgages differ from other types of home equity loans in a number of ways, one of which is higher costs,” said NerdWallet. “Fees will include mortgage insurance premiums, both initial and annual; third-party fees for closing costs; a loan origination fee, capped at $6,000; and a loan servicing fee. It’s also worth noting that reverse mortgage rates tend to be higher than traditional home loans, and will vary depending on how much you borrow, how you withdraw your proceeds, the home’s appraised value and your credit profile, among other factors.”
• If you get sick and have to permanently move out of your home, the loan will come due. “Seniors plagued with health issues may obtain reverse mortgages as a way to raise cash for medical bills,” said Investopedia. “However, they must be healthy enough to continue dwelling within the home. If an individual's health declines to the point where he or she must relocate to a treatment facility, the loan must be repaid in full, since the home no longer qualifies as the borrower's primary residence. Moving into a nursing home or an assisted living facility for more than 12 consecutive months is considered a permanent move, under reverse mortgage regulations. For this reason, borrowers are required to certify in writing each year that they still live in the home they're borrowing against, in order to avoid foreclosure.
• If you want to leave your home to an heir, “having a reverse mortgage on the property could cause problems,” said Investopedia, “if the heirs do not have the funds needed to pay off the loan.”