Many Americans have used the reverse mortgage as a way to make retirement living more affordable. With the cost of healthcare and other living expenses dramatically rising in recent years, it’s no wonder that thousands of people choose this option. In 2022, a national survey of homeowners who had reached retirement age found that many had trouble covering their everyday expenses, These mortgages let homeowners older than 62 turn part of their home equity into cash to help deal with these issues. This may sound like a good idea, but it’s widely known to have drawbacks too. Make sure you know what you’re getting into before heading down this path.
How Does a Reverse Mortgage Work?
A reverse mortgage is different than a traditional mortgage because you actually receive money from the lender instead of having to make monthly payments yourself. The loan only has to be repaid after you pass away, move out of your home permanently, or sell it.
Here’s how a reverse mortgage works:
- You find a lender and apply for a reverse mortgage.
- Upon approval the lender disburses monthly payments to the homeowner based on their home equity percentage.
- As a homeowner, you can receive money in one large sum, through a line of credit, monthly payments, or some combination of all of those.
- Over time, fees and interests are added to the amount that eventually must be paid.
- The homeowner retains title and ownership of the property.
The most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM), which is insured by the Federal Housing Administration (FHA). HECMs are subject to specific rules and regulations set by the U.S. Department of Housing and Urban Development (HUD). Private lenders also offer reverse mortgages with their own unique rules and qualifications that may be different from HECMs.
If you embark on the reverse mortgage path, it’s key to know that your loan balance goes up over time as interest and fees accumulate. However, remember you (or your heirs) never owe more than the value of your home when the loan actually comes due.
How do You Qualify for a Reverse Mortgage?
To be eligible, you have to meet several key requirements. At least one homeowner listed on the title of the property must be at least 62 years old. This requirement is set by HUD for all HECMs.
Beyond the age requirement, you have to have enough equity in your home in order to qualify. The required equity varies based on factors such as your age, property value, and current interest rates. If you are older and have more home equity, you typically are able to qualify to receive more funds.
Your lender will also require that the home you’re borrowing against must be your primary residence. That means that you live in the home for the majority of the year. If you have a vacation home or some other investment property, they don’t qualify for these types of mortgages.
The lender will also want to make sure you actually have the financial means to maintain the home and that you can pay property taxes, homeowners association fees, and insurance going forward. If you can’t do those things, it could, of course, lead to default and potential foreclosure.
How Do Reverse Mortgages Provide Retirement Income?
Perhaps the most attractive aspect of reverse mortgages is the different ways you get your funds. You have several options:
- A large “lump sum:” is a popular method that allows you to use a large percentage of your equity right away. People enjoy this option because it allows them to pay off big expenses they might have, such as debt, home maintenance and repairs, or substantial medical expenses.
- A Line of Credit: This alternative lets people withdraw cash as needed and is similar to a home equity line of credit (HELOC). This is a useful option because it offers a safety net of sorts for unexpected expenses or opportunities that pop up.
- Monthly payments: This method provides a steady stream of money to supplement other income sources that older adults receive, like Social Security, pensions, or retirement account withdrawals.
You can opt for tenure payments that continue for long as you reside in your home or term payments that span a predetermined period. By integrating a mortgage into your overall retirement strategy you can potentially bolster your financial security and better manage any unforeseen challenges during your retirement years.
What advantages does a mortgage offer for retirees?
The use of a mortgage in retirement is a topic that sparks debate among older homeowners yet it can serve as a valuable tool for retirement planning. One key benefit is eliminating mortgage payments while living in your home. With all Home Equity Conversion Mortgages the original mortgage loan is paid off before you receive any funds. The absence of mortgage payments allows you to allocate your cash flow towards expenses in your daily life.
These may include:
- Healthcare costs
- Making modifications to the home so you can live in it for life
- Some well-needed travel or leisure
- Consolidation of debt
- Everyday living expenses
This money not only can significantly improve your lifestyle in retirement, but will make your finances more stable during those years as well.
If you’re in a higher tax bracket or you just want to keep your tax liability down, then there’s another advantage with this type of mortgage. The government treats your proceeds in an advantageous way because that money is generally considered a loan advance and not taxable income.
Furthermore, when you use a reverse mortgage to complement your retirement income, it lets you protect other assets and investments, like your retirement accounts or brokerage portfolios. When you draw on the reverse mortgage proceeds, you aren’t tapping into your retirement accounts, and so they have a chance to grow. That leads to greater financial security in the long run.
What Are the Potential Drawbacks and Risks to Consider?
As we’ve seen, reverse mortgages have their advantages, but if you’re considering one, you must consider the possible drawbacks. One of the biggest concerns is the costs, which include:
- Origination fees
- Mortgage insurance premiums
- Closing costs
Along with these expenses, interest charges are added to the loan balance, gradually eroding your equity in your home.
If you rely on Medicaid or Supplemental Security Income (SSI), reverse mortgages present potential issues. The proceeds you earn could affect whether you qualify, so consult with a financial advisor to clarify how it may affect you.
There may also be implications for estate planning due to the increasing loan balance over time, potentially reducing the equity of heirs. If the person who borrowed the money passes away or permanently moves, then their family must decide whether to repay the loan, sell the house, or return it to the lender.
A significant risk is not meeting your mortgage responsibilities. For example, if you fail to pay property taxes or insurance, you may face foreclosure. Considering these downsides, weighing the advantages and disadvantages, and exploring choices before reaching a decision is essential.
What Are Some Alternatives to a Reverse Mortgage?
Looking for alternatives to a reverse mortgage? If you’re uncertain whether it suits your needs, alternative avenues are worth exploring. Here are some ideas:
1. Tap Your Home Equity with Alternative Financial Products
Other options let homeowners borrow against their equity while keeping control of the home, including a home equity line of credit (HELOC) or a cash-out refinance. These are different, though, in that they require you to make monthly payments and may also be more difficult to qualify for compared to reverse mortgages.
2. Sell Your Home and Downsize
Another option is to sell your home and downsize to a more affordable one. Why not make a change that lets you free up your cash and supplement your income while paying less on housing going forward?
3. Buy an Annuity
Many retirees buy an annuity to give themselves guaranteed lifetime income. An annuity is an insurance product that sends a steady stream of payments for a set period or the remainder of your life. Many like this type of product because it helps ensure you don’t outlive your savings.
4. Work Part-Time or Start a Small Business
Consider taking up part-time work or starting a business to supplement your income during retirement. This could be a good choice for those who enjoy staying active and connected within their community.
5. Stick to a Strict Budget and Invest in Long-Term Care Insurance
Follow a strict budget to reduce your expenses and make the most of your current money. Also, invest in long-term care so that exorbitant healthcare costs won’t exhaust your savings if you get sick.
Ultimately, the best approach varies based on circumstances, objectives, and risk tolerance. It’s important to consult an expert to explore options and develop a tailored retirement plan that suits your needs.
What Makes a Reverse Mortgage Right for You?
If you’re trying to discern whether this type of mortgage is right for you — think about several key factors, like your age, how much of your home you own, your retirement goals, and other ways you’re making money. Questions to ponder include:
- Do I own enough of my home to make this work?
- Does a reverse mortgage work well with my retirement goals?
- What other assets and income sources do I have?
- What impact will it have on my estate, and am I comfortable with that?
Get Guidance and Make a Decision
Seek advice from someone who knows more about these financial matters than you do in order to get informed. Also, discuss the situation with family members. This option may make sense if you:
- Are 62 or older with significant home equity
- Want to add on to the retirement income you already have
- Don’t have any trouble paying for home maintenance, taxes, and insurance
- Have a retirement plan in place that accounts for possible problems
It’s advisable to steer clear of a reverse mortgage if you own only a small portion of your home, don’t plan on living there for an extended period, and lack alternative sources of income.
The Application Process and Costs
If you decide to proceed, select a reputable lender, undergo counseling, and submit an application. It will usually take several weeks to a few months for the process to occur, and you need to provide documentation and have your home appraised. Consider costs such as origination fees, mortgage insurance premiums, and closing costs, which are all typically rolled into the loan balance.
Unlock Your Home’s Potential for a More Secure Retirement
A reverse mortgage can be a valuable tool to supplement your retirement income. However, it’s important to evaluate your circumstances and consider the pros and cons. By understanding the obligations, risks, and alternatives involved, you can make an educated choice on whether a reverse mortgage suits your needs. If you opt to move forward with it, work with a lender and seek advice from a financial advisor to help ensure a stable and comfortable retirement.
