Are There Downsides to a Reverse Mortgage?
If you’re age 62 or older with lots of equity in your home, you probably already know that there are several ways to get at that money. One option is a reverse mortgage. Some financial advisers will tell you categorically that a reverse mortgage is a bad idea. But is it really? Is there a downside to a reverse mortgage?
The income generated from a reverse mortgage can significantly bolster retirement income. Good deal, right? Before you sign papers to tap the equity in your home, you’ll want to understand what are the three types of reverse mortgages as well as the advantages and disadvantages of taking out this type of loan.
What Is the Upside of a Reverse Mortgage?
There are several advantages to taking out a reverse mortgage. A reverse mortgage provides a steady, tax-free stream of income with no monthly payments. If you collect Social Security or Medicare, that income will not affect your eligibility or your tax status. The loan doesn’t have to be repaid until the house changes ownership or occupancy, or the borrower dies. No matter what happens in the real estate market, you and your heirs will never have to make up the difference if the value of the home goes south. Reverse mortgages are also easy to get, since there are no income or credit score requirements.
What Is the Downside to a Reverse Mortgage?
The biggest downside of a reverse mortgage is its effect on equity. The interest compounds for many years and fees are charged on the proceeds, all of which can quickly erode your equity. You must have at least 50% equity in your home. Once the reverse mortgage ties up that equity, you are ineligible for other types of home equity loans in the future. If you enter a long-term care facility, you may be forced to sell. If you pass away, your surviving spouse or other heir may have to either sell the home or repay the loan. Should the house fall into disrepair, the loan will come due. Finally, the proceeds of the loan could affect your eligibility for Medicare and Supplemental Security Income.
What Are the Three Types of Reverse Mortgages?
You’ll also want to take a closer look at the three types of reverse mortgages to decide which, if any, of the options are right for you.
Home Equity Conversion Reverse Mortgage
A home equity conversion reverse mortgage (HECM) is the most-common of the three. An HECM can be used for any purpose. The money can be paid in a lump sum, monthly payments or a line of credit. Loan proceeds are guaranteed, even if the lender goes out of business.
This is the only reverse mortgage insured by the federal government and only available through FHA-approved lenders. Consequently, the borrower must pay mortgage insurance. In addition to an upfront insurance payment that is generally 2% of your home’s appraised value, ongoing annual insurance premiums of .5% of the outstanding balance must be paid when the loan is due.
Before approval for the loan, you’ll be required to meet with a counselor from an independent government-approved agency. The counselor will explain the financial implications of the loan.
Proprietary Reverse Mortgage
Although a proprietary reverse mortgage is not backed by the government, the benefits are basically the same as an HECM. However, if your home has a higher appraised value, this option could allow you to get a larger loan. As with the HECM, your private lender may require that you meet with a counselor.
Single-Purpose Reverse Mortgage
Single-purpose reverse mortgages are typically offered by state, local and nonprofit agencies and comprise the smallest percent of reverse mortgages. Unlike traditional reverse mortgages, single-purpose reverse mortgages can only be used for one type of expense, and the expense — typically property taxes or necessary home repairs — must be approved by the lender.
Single-purpose reverse mortgages are the least-expensive type of reverse mortgage since they generally tap into only a small part of the equity in the home. The proceeds are paid in one lump sum. These are a good option for lower-income borrowers who may not qualify for other types of loans.
The important thing to remember with any type of reverse mortgage is that it will erode the equity in your home with each passing year. Of course, the longer you live, the more advantageous the reverse mortgage will be for you — but no one knows how long they will live.
You’ll want to carefully weigh the pros and cons with a financial advisor before making a decision. You may have better, less-expensive options.
Let SmartCredit Help
Whether you’re applying for a single purpose reverse mortgage, an HECM or a traditional home equity loan, you’ll want to get the best deal possible. This means making sure your credit score is an accurate reflection of the hard work you put into maintaining your credit standing.
SmartCredit helps you do just that. With SmartCredit, you’ll have access to unique credit management tools that allow you to take control of your future score with proprietary features that help you monitor and optimize your credit score, as well as time your loan application for optimal success. SmartCredit can give you the peace of mind you need, so you can make the right financial decision for your situation. Learn more today.