Pros & Cons of Reverse Mortgages
As a homeowner saving for retirement or a homeowner near retirement age, a reverse mortgage can be an appealing way to put your home equity to work.
However, despite the numerous advantages, it comes with several cons that may make you turn around and run for the hills. Before you head to your nearest lender to take on a reverse mortgage, you must understand how it operates and all the pros and cons.
What is a Reverse Mortgage?
A reverse mortgage is a seemingly simple FHA loan that can feel like free money. In a world where money can be challenging to earn, receiving payments just for owning a home can appeal to many.
However, in reality, it’s still a loan. A reverse mortgage, also known as a Home Equity Conversion Mortgage (HECM), comes with all the bells and whistles of a traditional loan. These costs include:
- Compounding Interest
- Service fees
- Mortgage insurance
- Other costs and fees
While it may not seem like much, these are costs that can eat up your home equity and leave your heirs with little to nothing regarding home inheritance. However, if this mortgage is utilized correctly, it can become a financial product that helps add stability for many retirees.
Like a cash-out refinance, a reverse mortgage lets homeowners convert a portion of their home equity into cash. The appeal here is that reverse mortgages have lenders pay the borrowers in monthly installments instead of borrowers paying lenders every month.
However, the debt accrued by the borrower increases over the life of the mortgage and settling the amount can take a large bite out of whatever home equity is left.
Loan repayment doesn’t begin until the moment the borrower moves out, sells their home or passes away. While little to no home equity may be fine for some, there’s also the risk of the home falling into foreclosure.
Reverse Mortgage Qualifications
When considering a reverse mortgage, it’s beneficial to focus on those that are FHA-insured and follow federal guidelines. Focusing on these types helps ensure you have consumer protection and stay protected under FHA requirements.
Some qualifications include:
- Being at least 62 years old
- Zero federal debt delinquency
- The home must be your primary residence
- Financial ability to keep up with paying insurance, taxes and other fees
- The home must meet FHA requirements
There are several payment options with a reverse mortgage. You can set up a line of credit, opt to receive payments as long as you reside in that home or set up an agreed term.
Pros of Reverse Mortgages
As a homeowner struggling to meet monthly payments or a retiree wanting some cash flow, a reverse mortgage can be what you’re looking for.
Get Cash Without Leaving
One of the major benefits of a reverse mortgage is staying in your home and receiving cash without having to sell it. Receiving monthly payments without selling your home means you don’t have to worry about downsizing or meeting recurring mortgage payments.
The cash flow is highly beneficial for those with minimal cash savings or money to invest. It’s a mortgage that benefits those with significant wealth built in their homes.
Getting a reverse mortgage allows those who are house rich and cash poor to finally taste the fruits of patiently building home equity.
Zero Tax on Monthly Payments
The key to a successful and financially free retirement is tax-efficient money management. Even though you receive steady payments with this mortgage, the IRS doesn’t view it as income. Unlike distributions from traditional retirement income sources like an IRA, the IRS considers any payments part of a larger loan. That means it won’t affect the formulas determining Medicare benefits and Social Security payouts.
This is a significant benefit of FHA-insured reverse mortgages. One of the understandable concerns of these mortgages is that a homeowner may have to pay extra if the sale proceeds don’t cover the loan amount.
Fortunately, FHA-insured reverse mortgages have FHA mortgage insurance. This insurance covers any difference between the sale amount and the amount owed.
So while you may have to liquidate when moving out, you’re guaranteed to owe no more than what the home sells for.
The benefit of paying the difference between the sale price and the amount owed also applies to those passing down homes to their heirs.
In the event the home value ends up being less than the amount owed, heirs don’t have to worry about paying the difference in the balance. Of course, this typically only applies to reverse mortgages that are FHA-insured.
No Early Repayment
As mentioned earlier, loan repayment doesn’t begin until one of the following occurs:
- Borrower passes away
- Borrower decides to sell the home
- The home no longer serves as the borrower’s primary residence
Another benefit is that if you decide to sell your home and it sells for more than what you owe on the reverse mortgage, the extra amount is 100 percent yours to keep.
Cons of Reverse Mortgages
While the benefits of a reverse mortgage seem like a dream come true, there are several cons worth considering.
Larger Loan, Smaller Home Equity
Unlike traditional loans that borrowers pay to reduce over the years, a reverse mortgage comes with increased debt over time.
It’s not only the principle that a borrower owes, but they are also responsible for other costs like mortgage insurance, interest and fees. While it may not seem like much at first, it can compound to a significant amount.
A reverse mortgage can take a significant bite out of your home equity. However, the size of that bite depends on how large your loan balance is.
Most homeowners will be left with minimal or zero home equity unless home prices skyrocket. Additionally, heirs must repay the entire loan balance or at least 95 percent of the home’s appraisal value to keep the home.
Potential Risk of Foreclosure
Unfortunately, homeowners are still exposed to foreclosure with a reverse mortgage. While there aren’t any monthly mortgage payments to meet, homeowners must stay up-to-date with applicable maintenance costs, property taxes and homeowner’s insurance.
As briefly mentioned earlier, a homeowner must keep up with these payments and home requirements. If not, a lender will be quick to foreclose on the property.
However, some lenders may help you prepare for this by creating a separate account using a portion of the monthly payments to pay for these costs.
In addition to property taxes and maintenance costs, a homeowner is also responsible for several other fees. These include mortgage insurance, servicing fees origination and any closing costs.
You can discuss rolling any fees into the overall loan if you want, but this may result in lower monthly payments you receive.
A reverse mortgage is seemingly simple at first, but it becomes complex and convoluted the more you look into this financial product. It comes with a long list of rules that can lead to losing your home and other risks that may not be worth the monthly payments.
Before signing a reverse mortgage, it’s beneficial to discuss the terms in detail with your lender to ensure you have a complete understanding.
Is a Reverse Mortgage Right for Me?
A reverse mortgage is an excellent option for some but can financially ruin others. Typically there are only a few instances when a reverse mortgage may be right for you. If you want a reverse mortgage, you’ll want to plan to stay in that home for a very long time, ensure you can cover any costs and if your home value has increased a significant amount.
Ultimately, taking out a reverse mortgage is your decision, but it’s a decision that shouldn’t be taken lightly. Get in touch with our specialists to discuss your goals and determine if a reverse mortgage is right for you!