What are the Pros and Cons of Reverse Mortgages?
Since the launch of the first reverse mortgage in the USA in 1961, homeowners have benefitted from this avenue for releasing equity from their home to cover retirement costs or other expenses. The popularity of these loans may have peaked around 2008, but they are still heavily promoted on TV and in media targeting senior homeowners. Depending on your circumstances, they may well be worth considering but bear in mind these reverse mortgage pros and cons first.
Reverse Mortgage FAQ
In a nutshell, a reverse mortgage allows a homeowner to convert equity in their property into cash. The homeowner transfers equity in the property to a lender in exchange for receiving (instead of making) monthly payments. When the homeowner either dies or sells the property, the balance of the loan is repaid.
There are three common types of reverse mortgage in the USA:
- Single-purpose: These are the least expensive but are not widely available in every state. They allow equity release for a specified purpose, such as home repairs or paying property taxes.
- Proprietary: This provides equity release from private lenders.
- HECM: These federally insured Home Equity Conversion Mortgages (HECMs) are the most common type, and are backed by the U.S. Department of Housing and Urban Development (HUD).
Qualifying for a Reverse Mortgage
To qualify for a reverse mortgage, you must first have significant equity in your home. For the federally backed loan, you must also be 62 years of age or older. Assessment criteria are based on the appraisal value of the home, not on the property owner’s income or credit score. However, lenders will confirm that the applicant has sufficient funds to cover property taxes and insurance, and applicants must attend mandatory counseling to evaluate their understanding of, and suitability for, a reverse mortgage. As of 2020, the maximum reverse mortgage loan amount stands at $765,600.
Common Misconceptions about Reverse Mortgages
Until the 2008 crash, reverse mortgages were seen as something of a last resort in unfavorable circumstances for providing income in retirement. That is no longer the case. Lower borrowing limits now rule out reverse mortgages based on 100% equity. Other common misconceptions include:
- Heirs are liable for repaying the mortgage
Even surviving spouses are not liable for reverse mortgages, but the home will have to be sold to repay the loan. The non-recourse clause means that the loan balance cannot exceed the appraised value of the home.
- Any home is eligible
Reverse mortgages are only available if you own the home outright or have a low outstanding balance. You cannot buy a house with a mortgage and convert it immediately to a reverse mortgage.
- It’s an investment
Some lenders will promote a reverse mortgage as an instrument to invest in home improvements, or to release funds for investing in other financial products. That would be misleading. A reverse mortgage is, however, a viable way to turn illiquid property equity into liquidity.
- You’re getting paid to live in your home
Even though a reverse mortgage means you receive payments every month, there is a loan to be settled (with interest) at the end of the loan term, and you are still responsible for paying property taxes, insurance and utilities. If these aren’t paid, your lender may request early repayment of the full loan.
The Pros of Reverse Mortgages
Reverse mortgages are particularly suitable for seniors with no heirs or surviving dependents. They allow you to release cash to cover medical expenses or retirement costs, for example, without selling your home or giving up the title to your property. You don’t have to pay back the loan while you’re living in your home, and revenue is usually tax-free and will not affect your Social Security or Medicare benefits.
The Cons of Reverse Mortgages
When you take out a reverse mortgage, you are reducing equity in your own home, so you have fewer assets to leave your heirs. At the end of the mortgage term, when you sell your home or die, the loan has to be repaid. This amount increases over time as (non-tax-deductible) interest accrues. In addition, reverse mortgages typically charge higher interest rates than conventional mortgages and incorporate origination fees, servicing fees and closing costs, as well as mortgage insurance. In some cases, a personal loan might be a better option than a Single Purpose loan, or even selling a home and downsizing to a smaller property as a means of releasing cash.
It’s no secret that most reverse mortgage offers come with compelling sales pitches, which can be harder to evaluate with a cool head when financial circumstances are tight. As with any major financial decision involving property, weigh up the pros and cons with the support of a trusted financial advisor.