Under the right circumstances reverse mortgages, also known as a Home Equity Conversion Mortgage (HECM), can be a good means of supporting your retirement. On the other hand, they can also turn out to be an expensive way to borrow money.
To help determine if a reverse mortgage is right for you, let’s take a closer look at what a reverse mortgage is, review some background information, and discuss the pros and cons associated with this financial decision.
What is a Reverse Mortgage?
Simply put, a reverse mortgage is a loan that uses your home as collateral. The funds provided through the reverse mortgage can be used in a variety of ways such as supplementing your income, paying off debt, or making a large purchase.
When you take out a reverse mortgage, it’s important to note your house will remain in your name, and the income you receive is tax-free. Another point to note is that no matter how much you owe on your reverse mortgage, you can’t owe more than the value of your home.
Reverse mortgages can be an attractive option for some because you are not required to make payments as long as you live in your home. On the contrary, once you leave your home for more than twelve months, sell the residence, or pass away, the outstanding balance of the loan must be repaid, typically with interest.
It is worth noting that the first reverse mortgage was done right here in Portland, Maine as a tool to assist a local widow who wanted to stay in her home after her husband’s passing.
Fees Associated with a Reverse Mortgage
While you won’t be required to make payments as long as you live in your home, a reverse mortgage comes with its fair share of fees, and can actually cost more than a conventional mortgage.
Generally speaking, lenders will charge 1) mortgage insurance premiums (initial and annual) 2) third-party charges 3) origination fee 4) interest and 5) servicing fees. These fees can be paid upfront or by financing them over time from the proceeds of the loan.
How Much Can Be Borrowed?
The amount that can be borrowed depends on several factors including your age, the value of your home, and current interest rates. The older you are, and the more equity you have in your home, the more you can borrow – especially if interest rates are low.
Reverse mortgages do have limits on how much you can borrow your first year, and how much of the value of your home you can borrow against.
As of 2022, the HECM FHA mortgage limit is $970,800. So, even if your home is valued at $5 million, the HECM will only let you borrow against $970,800 of its value. You would then be able to borrow anywhere between 35-75 percent of this amount depending on age, equity, and interest rates.
Who is Eligible to Take Out a Reverse Mortgage?
In order to qualify for a reverse mortgage, the individual must be at least 62 years old and own their home outright. Additionally, the home must be the primary residence (i.e. no secondary residence or real estate property), and there must be documentation that the home owner maintains the property, and pays property taxes, insurance, etc.
Who is the Ideal Candidate for a Reverse Mortgage?
As noted in the introduction, a reverse mortgage is not a good fit for everyone. However, if you are over the age of 62, own your own home, and meet any of the following scenarios, you might be a good candidate for a reverse mortgage.
- Seniors who are encountering significant costs late in life (and may not have Long-Term Care Insurance)
- People who have depleted most of their savings, but have considerable equity in their primary residences
- People who don’t have heirs who wish to inherit the home
What are the Potential Benefits of a Reverse Mortgage?
For the right candidate, a reverse mortgage can help you:
- Strengthen your retirement. A reverse mortgage can allow you to turn an otherwise illiquid asset, your home, into cash that you can use to cover expenses in retirement.
- Avoid downsizing so you can live in your home longer. Instead of selling your home to liquify your asset, you can keep your primary residence and get cash out of it. This can help you avoid downsizing or getting priced out of your neighborhood if you had to move.
- Pay off Existing Home Loans. Your home doesn’t have to be paid off in order to take out a reverse mortgage. In fact, you can use the proceeds of a reverse mortgage to pay off an existing home loan. This frees up money to put toward other expenses.
- Reduce Tax Liabilities. According to the IRS, money you get from a reverse mortgage is considered to be a loan advance rather than income. That means the funds aren’t taxed, unlike other retirement income such as distributions from a 401(k) or IRA.
What are the Potential Downfalls of Taking Out a Reverse Mortgage?
While a reverse mortgage might seem to have many benefits, there are also some very serious risks to consider which include:
- Losing your home to foreclosure. To qualify for a reverse mortgage, you have to maintain the payment of your property taxes, homeowners insurance, HOA fees and any other expenses associated with owning your home. The home must also serve as your primary residence for most of the year. If at any point during the loan period you become delinquent on these expenses, or spend the majority of the year living outside the property, you could default on the reverse mortgage and lose your home to foreclosure.
- Compromising other retirement benefits. While income generated from a reverse mortgage may have certain tax benefits, taking out this loan could impact your ability to qualify for other need-based government programs such as Medicaid or Supplemental Security Income (SSI). You should discuss this with a benefits specialist to ensure your eligibility in these programs won’t be compromised.
- Limiting, or even eliminating the opportunity to leave a legacy to your heirs. A reverse mortgage requires that the full balance be paid when you die. It also eats away at your home’s equity over time. This combination usually results in your heirs having to sell the home in order to repay the debt. As a result they are left with little to no inheritance.
- Paying high upfront fees. With loan origination fees up to $6,000, upfront mortgage insurance premiums worth 2% of your home’s value, and other closing costs, reverse mortgages are more expensive than other home loan types. In short, a reverse mortgage can be an expensive way to borrow money.
So, Is a Reverse Mortgage Right for You?
The answer is never an easy yes or no. Like any big financial decision, you should consult your financial advisor or a trusted expert to help you evaluate the pros and cons of applying for a reverse mortgage.There are many cases when an individual should avoid applying for a reverse mortgage. Be sure you fully understand reverse mortgage pros and cons before taking one on.