Key Takeaways
For homeowners over age 62, a reverse mortgage can provide tax-free income that allows you to continue living in your home, pay bills, supplement your income, and more. Reverse mortgages aren't free money: Borrowing costs can be high, and you'll also need to pay homeowner's insurance and property taxes. Reverse mortgages can complicate life for your heirs, especially if they don't want the home or if the home's value doesn't cover the debt.
If you watch TV, you've probably seen Tom Selleck and Henry Winkler touting reverse mortgages as a valuable source of income for retirees and those with limited funds. While this type of loan is worth taking out, it's not for everyone. Here are its pros and cons.
Benefits of a Reverse Mortgage
Better control over retirement spending
Many seniors experience a significant drop in income during retirement. A reverse mortgage can help you make up for this loss without dipping into your savings. And with no monthly payments required, it can help free up some space in your monthly budget.
There's no need to move.
A reverse mortgage allows you to retire in your home instead of having to move out, and although a reverse mortgage does have fees and other costs, it may cost less in the long run than buying another home or renting in a new location.
You don't have to pay tax on your income
The money you get from a reverse mortgage isn't taxable because the IRS considers it “loan proceeds” and not income (though it may be considered income by other agencies, which we'll discuss later).
You're protected if your balance exceeds the value of your home
Because the balance of a reverse mortgage grows over time, you could eventually owe more than your home is worth. However, because a reverse mortgage is what's called a “non-recourse” loan, the amount you owe never exceeds the value of your home, and the lender cannot make a claim against any of your other assets or the assets of your heirs.
Your heirs have options
Although a borrower can repay a reverse mortgage at any time, repayment is usually not due until needed, such as when the borrower moves, sells the home, or dies. In the case of an estate, heirs may be left with a few options.
Sell the property to pay off the debt and keep the assets that exceed the loan balance Pay off the debt with your own funds If the property is worth enough, keep the property and refinance the balance of the reverse mortgage Allow the lender to assume ownership of the property if the debt exceeds the value of the property (or if your heirs simply don't want the home)
This last option allows the lender to file a claim with the insurance company (in most cases the Federal Housing Administration (FHA), which oversees the Home Equity Conversion Mortgage (HECM), the most common type of reverse mortgage) for the outstanding balance.
Disadvantages of Reverse Mortgages
You need to pay a fee
Reverse mortgages incur the following fees:
Origination fee (capped at $6,000 for HECM) Mortgage Insurance Premium (MIP) Third-party settlement fees, such as appraisal and listing fees Monthly service fee up to $35
Many of these costs can be rolled into the principal of your loan, which can significantly increase the amount you borrow.
You can't deduct interest until you pay it off
While you may have been able to deduct mortgage interest on your taxes while you were paying off your mortgage, you can't deduct reverse mortgage interest each year. You only get that benefit when you pay off the loan in full.
You may inadvertently violate other program requirements
Taking out a reverse mortgage may cause you to violate asset or income limitations for the Medicaid and Supplemental Security Income (SSI) programs, which could affect your eligibility for these benefits.
There are still housing-related expenses
A reverse mortgage does not excuse you from paying property taxes, homeowners insurance, or homeowner's association fees. If you fail to pay these fees on time, you may violate your reverse mortgage agreement and your home may be foreclosed on.
Survivors may encounter problems
If the borrower no longer lives in the home, the reverse mortgage must be repaid in full or the home must be surrendered to the lender. This scenario can occur not only upon the borrower's death, but also upon moving into a nursing home or long-term care facility.
This situation can create complications for non-borrowers who still reside in the home. There are protections for surviving spouses, but they only apply if you were married before obtaining the reverse mortgage.
Repayments may also be much larger than expected. If you hadn't paid off your balance at all or only paid very little before the triggering event, it may be even harder to pay it off now.
Who is a good fit for a reverse mortgage?
Considering all the potential complications and risks, is a reverse mortgage a good idea? For some homeowners, the answer might be yes if:
If you plan to stay in your home for a long time – With a reverse mortgage, you’ll pay another set of settlement costs, so ideally you’ll want to stay in your home until you’ve recouped those costs. If you’re 62 and plan to make your current home your lifelong home, a reverse mortgage might make sense. You need more money to manage your day-to-day expenses – If you’re struggling on a limited income, a reverse mortgage can help you pay some bills. Your home’s value is rising – If you live in a market where home prices are rising, the value of your property may have increased by the time you or your heirs pay off your loan.
Many state and local government agencies and organizations offer assistance to seniors who have trouble paying their bills. AARP maintains a list of state-by-state benefit programs.
Who is not a good fit for a reverse mortgage?
Here are some signs that a reverse mortgage may not be right for you.
You're planning on moving – Remember: you need a long time frame to make it worth paying all the settlement costs, mortgage insurance premiums, and other fees Health issues may require you to move – A reverse mortgage requires you to continue living in your home, which means if you move to a nursing home or assisted living facility, you may have to pay off the loan in full You're struggling to cover other home-related expenses – If you have trouble coming up with the cash for property taxes and homeowners insurance, it's best to avoid a reverse mortgage. You'll need to continue paying these expenses to meet the requirements of the loan.
Should I take out a reverse mortgage?
Reverse mortgages have gotten a bad rap because of scams that prey on unsuspecting seniors, and even legitimate companies use deceptive marketing to trick homeowners into taking out a reverse mortgage. The simple rule is to be very careful about putting your home at risk.
Still, there's at least one important reason to consider a reverse mortgage: rising property values. Home prices have risen over the past few years, creating a great opportunity for many homeowners to take advantage of the value of their equity.
Don't forget that there are other options for accessing cash, so compare a home loan vs. a reverse mortgage to see which one best suits your needs.
Next steps to getting a reverse mortgage
If you're considering a reverse mortgage, first review the reverse mortgage requirements to see if you qualify, and a reputable reverse mortgage lender can help you learn more about your options.
FAQ
What are the requirements for a reverse mortgage?
The main requirements for a reverse mortgage are that you are of eligible age (over 62, and in some cases over 55), have sufficient equity in your home, and continue to live in your home, the latter of which includes maintaining homeowners insurance, keeping your home in habitable condition, and continuing to pay property taxes.
What are the alternatives to reverse mortgages?
If you don't qualify for a reverse mortgage, you may still qualify for a home equity loan, a cash-out refinance, or a home equity line of credit (HELOC).
Source link