Reverse mortgages are a financial tool marketed toward seniors who are looking to cash in on the equity in their homes. Homeowners age 62 and older can borrow against their home’s value and the loan doesn’t have to repaid until you vacate the property. Reverse mortgages are touted as a low-cost way to create supplemental income streams in retirement but they’re not for everyone. Before you take out this kind of loan, you need to weigh the pros and cons carefully.
How Does a Reverse Mortgage Work?
In broad strokes, a reverse mortgage is similar to a conventional mortgage, just backwards. With a conventional mortgage, you borrow money from the lender and make payments with interest until it’s paid in full. With a reverse mortgage, the lender makes payments to you based on the amount of your home’s equity. You can use the money as you see fit, including paying off any existing mortgage balance on the home.
You have to be at least 62 years old to qualify for a reverse mortgage loan. Other than that, however, the requirements are much less strict than for a traditional mortgage. There’s no income or credit threshold that you’ll need to meet in order to qualify.
There are few different types of reverse mortgages, but the most common by far is the home equity conversion mortgage (HECM). When you take out a reverse mortgage, you can either receive payment in one lump sum, monthly installments or even a line of credit.
A reverse mortgage loan only needs to be repaid if you pass away or if your home stops being your primary residence. This could be the case if you decide to sell your house or if you move into a long-term care facility. If you die after taking out a reverse mortgage, your heirs can either sell the house to pay off the loan or pay off the loan with other funds and maintain ownership of the home.
Advantages of Taking Out a Reverse Mortgage
If you’re looking to tap into your equity to pay off debt or tackle some home improvement projects, a reverse mortgage is generally easier to qualify for than a traditional home equity loan or line of credit. Typically, there are no minimum income or credit score requirements that you have to meet. You may be able to get a better interest rate than you would with another type of loan.
Homeowners are allowed to retain the title to the home with a reverse mortgage. This means you can pass it on to your children or other heirs after your death. If you end up moving, you can still receive any left over equity if you sell for more than the reverse mortgage amount. The same is also true for your beneficiaries. They won’t be responsible for any equity shortfalls if your home loses value. As an added bonus, you may qualify for the mortgage interest deduction which can offset some of your tax liability.
Reverse mortgages also offer some flexibility in how you can receive your payments. Depending on the lender, your choices may include fixed monthly payments, a lump sum payout or a line of credit. You may even be able to combine more than one of these payment options to help fill in the financial cracks. If you’re already receiving Social Security or Medicare benefits, reverse mortgage payments won’t impact your eligibility.
The Downsides of a Reverse Mortgage
Since it’s a loan, you’ll have to cough up some money for origination and application fees. There are less stringent requirements to qualify for this type of loan. But the rates tend to be higher since the lender is assuming a larger risk. If you have a substantial amount of value in your home, these fees can easily add up to a major expense. If the lender’s also charging a high interest rate, you may not actually get much money out of it.
Applying for a reverse mortgage can also have an impact on your ability qualify for Medicaid coverage, which is need-based. One of the things that determines whether you’re eligible for Medicaid is the total amount of assets you have. Some states allow you to exclude some or all of your home’s value. However, there are specific limits on how much you can have in your bank account. If you park the cash from your reverse mortgage loan in your checking or savings, your application for Medicaid could be denied.
Residency requirements are also an issue with reverse mortgages. For example, if you end up moving into a long-term care facility, you’ll have to repay the loan in order to keep the property. You also need to think about the potential impact on your heirs. If they can’t come up with the money to pay off the reverse mortgage after you die, they have to sell the home. They can use other estate assets to clear the loan and keep the property but this diminishes the amount of their inheritance.
Finally, you’ll still have to cover the cost of maintenance and upkeep on the home while you’re living in it. This is in addition to what you’ll pay for homeowner’s insurance and property taxes. If you don’t have a lot equity in your home, a reverse mortgage may not provide enough of a financial benefit to justify the loan.
The Bottom Line
A reverse mortgage can give your budget a much-needed boost. But it can also create some financial difficulties down the road once you leave the home. If you have to shell out big bucks for fees or create an unnecessary burden for your children, a reverse mortgage could be more trouble than it’s worth. Consider consulting with an estate planning professional or a financial advisor to look at your situation.
Tips for Boosting Your Retirement Income
- Social Security benefits aren’t enough to replace having your own retirement savings. However, they can certainly help with your living expenses in retirement. Try our Social Security calculator to see how much of a benefit you can expect. Our cost of living calculator can give you an idea of how much you’ll need.
- You may want to consider working with a financial advisor to ensure you’re ready to retire by the time you want to. According to industry experts, people who work with a financial advisor are twice as likely to be on track to meet their retirement goals. SmartAsset’s financial advisor matching tool can find you a local advisor who meets your needs.
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