A reverse mortgage is a financial tool that allows a homeowner to cash in on the equity in their homes. To do this, a homeowner would borrow against their home’s value and receive a lump sum of money, monthly payments or a line of credit in exchange. Reverse mortgages are touted as a low-cost way to create supplemental income streams in retirement, but they’re not for everyone. A reverse mortgage is a big decision that can have a major impact on your financial situation, so if you’re considering one, it’s a good idea to find a financial advisor to consult with first.
What Is a Reverse Mortgage, and How Does It Work?
In many ways, a reverse mortgage is similar to a conventional mortgage, only backwards. With a conventional loan, you borrow money from a lender and make payments with interest until everything’s paid back in full. With a reverse mortgage, the lender makes payments to you based on the equity you hold in your home. You can then use that money as you see fit.
First and foremost, you must be at least 62 years old to qualify for a reverse mortgage. Other than that, the requirements are much less strict than those of a traditional mortgage. In fact, there’s no income or credit threshold that you’ll need to meet in order to qualify. However, you must lay claim to enough equity in your home to get a reverse mortgage.
There are few different types of reverse mortgages, but by far the most common is the home equity conversion mortgage (HECM). When you take out a reverse mortgage, you can choose to receive either a single payment in a 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 is no longer your primary residence. This might 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 do so with other funds and, in turn, maintain ownership of the home.
Advantages of 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. Additionally, you may be able to get a better interest rate than you would wind up with 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 leftover equity if you sell the home for more than the amount of the reverse mortgage. The same is also true for your beneficiaries, as 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 help 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 meet your specific needs. If you’re already receiving Social Security or Medicare benefits, reverse mortgage payments won’t impact your eligibility.
Downsides of a Reverse Mortgage
Since a reverse mortgage is technically a loan, you’ll have to cough up some money for origination and application fees. Interest rates also tend to be higher than a conventional mortgage since the lender is assuming a larger amount of risk. If you hold substantial equity in your home, these fees can easily add up to become a major expense. If the lender’s also charging a high interest rate, you may not actually get much benefit 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. So if you park the cash from your reverse mortgage in your bank account, your application may get 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.
Should You Get a Reverse Mortgage?
At its core, a reverse mortgage allows for an infusion of cash into your financial life during a sometimes tumultuous time: retirement. Therefore, if you’re in need of some extra money, this type of loan is well worth looking into. The money paid out through a reverse mortgage is often tax-free. That makes it a relatively simple way to ease your monthly budget without taking on too many extra costs.
You may go through the reverse mortgage application process and find that the associated fees are quite high. If this describes your situation, you should likely steer clear of a reverse mortgage. There are other options for gaining money in retirement, so don’t feel overly attached to this option.
On other occasions, you may find that you simply don’t have access to reverse mortgages. This will happen if you own either very little or all of the equity in your home.
A reverse mortgage can give your budget a much-needed boost, but it can also create some difficulties once you leave your 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 a financial advisor or an estate planning professional if you have questions about which route is right for you.
Tips for Boosting Your Retirement Income
- You may want to consider working with a financial advisor who can help you plan out your retirement income. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
- 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.
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