Reverse mortgages are something to consider if you’re preparing to retire. This sort of loan is a tempting solution if you’re worried about not having enough to live on in retirement.
What is a Reverse Mortgage?
A reverse mortgage is a type of loan available to seniors, age 62 and older. Essentially, this loan borrows against the value of your home, and can give out a lump sum, monthly payment, or line of credit.
Payment Methods
There are six ways to receive your money from a reverse mortgage, and the choice will depend on what your exact needs are.
- Lump sum
- Equal monthly payments
- Term payments
- Line of credit
- Equal monthly payments with line of credit
- Term payments with line of credit
Pros to Reverse Mortgages
Unlike a normal forward mortgage that is used to purchase a home, a reverse mortgage does not require loan payments.
The entirety of the loan’s balance is due upon the death of the borrower, or if they permanently move away or sell the home. This means that during your lifetime, or at least as long as you remain in your home, you will have access to a sum of money without needing to pay it back. It is designed to take the burden off of the family left behind, so the value of the home being sold goes into paying the loan. In fact, if the home is sold for more than what is owed on the loan, that money goes back to the homeowners, or the homeowner’s estate.
For those worried about taxes, don’t be! While this loan may feel like income, it is not considered as such by the IRS. It is a loan advance, and is not taxable.
This may seem similar to a HELOC. But unlike a HELOC, you don’t need to have an income or an excellent credit score to qualify for a reverse mortgage. This is because of the fact that your home is the collateral. It is the only way to access the equity of your home without selling the home outright, or having to qualify for a loan based on income or credit. In other words, it’s ideal for seniors going into retirement.
Cons to Reverse Mortgages
Reverse mortgages sound like a great option for retirees, but there are a few things to watch out for as well.
If you choose a lump sum, it is important to take note of the interest rate. This is the only method that has a fixed interest rate, while the others have adjustable interest rate. If you do a lump sum, you’re locked in at that rate no matter what!
One of the most obvious downsides to this loan is, in fact, the interest. A good chunk of your equity will go toward fees and interest. It also means that you probably won’t be passing down the property to the rest of your family after you pass away. If you want to get the most value out of your home equity, you’re better off selling it – the upside is of course that you get to stay in your home. This is designed to be a long-term financial solution, not a short-term one.
Another complicated aspect is the fact that you can’t predict when you will pass, and therefore it will be difficult to maximize your use of the money you get. If you go with a payment plan that doesn’t offer a lifetime income, like the lump sum option, you might run out of money in the loan part way through your retirement. This challenge can be overcome by budgeting smartly, but it could require a good deal of self-control to not blow it all early!
A less common, but still important to consider downside, is other people who live in your home. Once the homeowner who holds the loan passes away, any friends or family that were also living in your home won’t have any rights to the home. They will have to find a new place to live on short notice unless your family can purchase the home back. In general, a surviving spouse will be safe, but there are still certain situations in which a spouse could lose the home after their partner’s passing. To be safe, make sure that both of you are on the title of the house, and are both borrowers on the loan.
While not necessarily a downside, the rules of a reverse mortgage require that you stay up to date with property taxes and homeowners insurance, as well as keeping the home in good repair. If you stop living in the home for longer than a year, even for long-term medical care, you will need to repay the loan, which likely means selling the house.
You also can’t borrow 100% of the value of the home, since a good chunk of change goes to paying fees and interest. While the actual amount you can borrow will depend on your exact situation as well as the lender, data shows that the average borrower will receive about 58% of their home’s value.
The Bottom Line
Reverse mortgages are a bit of a double-edged sword. But they can be an invaluable financial tool for senior homeowners. If you understand how loans work and what the risks are, you should be just fine! Always be on the lookout for scammers and untrustworthy lenders and get multiple quotes. All in all, reverse mortgages are great if you need the money, but like any loan, involve interest. If you're smart about it, interest will be your only concern!
