The Pros and Cons of Reverse Mortgage Loans
What is a reverse mortgage?
A reverse mortgage loan is a home equity product designed for older homeowners. Unlike other mortgages, these don’t require monthly payments. Instead, the lender pays the homeowner.
Here are some other important things to know about reverse mortgages:
- They’re for seniors. Government-backed reverse mortgages require borrowers to be at least 62 years of age to qualify. Private reverse mortgages sometimes have lower age thresholds (down to 55 in some cases).
- There are several payment options. With reverse mortgages, you can choose to get a lump sum payment upfront, monthly payments across a certain time period, a line of credit or some combination of these.
- The loan amount depends on many factors. Lenders base loan amounts on the borrower’s age, the value of the home and the interest rate. For government-backed reverse mortgages, the maximum loan amount is $970,800 as of 2022.
- Most don’t have minimum credit scores. Unlike other loan programs, most reverse mortgages — at least the government-insured kind — don’t have minimum credit score requirements. Instead, lenders look at your income, debts and payment history to get a pulse on your full financial picture.
- You never make a payment. The balance on a reverse mortgage — plus interest — comes due when you sell the house, move away for at least one year, or pass away.
Though these loans don’t involve monthly mortgage payments, reverse mortgage borrowers still need to stay current on their homeowners insurance, property taxes and homeowner’s association (HOA) dues. Failing to do so could mean losing their house.
Reverse mortgage requirements
The exact requirements of a reverse mortgage depend on whether it’s a government-backed mortgage (called a Home Equity Conversion Mortgage or HECM) or a proprietary reverse mortgage from a private company.
With HECMs, you work with a private lender, but the Department of Housing of Urban Development insures the loan — meaning they’ll cover some of the loss if you default. This protection often results in a lower interest rate than proprietary loans can offer.
You’ll need to be at least 62 for a HECM, and you also must participate in HUD-approved HECM counseling before your application can be approved. Additionally, the mortgaged property must be:
- Your primary residence
- Meet the Federal Housing Administration’s minimum property standards
- A single-family, one- to four-unit property or FHA-approved condo
- Have no mortgage attached to it or a low loan balance
If you’re considering loans from private reverse mortgage lenders, the qualifying requirements will vary. Just keep in mind: HECMs come with a number of federal protections that private mortgages may not. First, they’re non-recourse, which means you’ll never owe more than your home is worth — even if your home’s value drops after you take out the loan. You’re also protected if your lender goes out of business, and interest rates tend to be lower than other options too.
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How does a reverse mortgage work?
Reverse mortgages pay you out of your home equity. Think of it like an advance on the eventual sale of your house. The lender will advance you cash, either upfront or spread out over time. Then, when you eventually move or pass on, the proceeds from your home sale will be used to pay off the amount you borrowed — plus interest.
There are several payout options with a reverse mortgage. You can opt for:
- An upfront lump sum payment: After closing on your loan, you’d get your loan amount in full. This is the only payment option if you choose a fixed-rate loan.
- A line of credit: This turns your equity into a credit line you can withdraw from as needed. It functions like a credit card in that you only borrow what you need. This is only an option if you choose an adjustable-rate HECM, which means your interest rate can rise and fall over time.
- Monthly payments: With this type of reverse mortgage, you can take equal monthly payments for as long as you live in the home or over a set time period (say 15 years). You can also combine one of these options with a line of credit. This would give you consistent monthly income, plus access to extra cash should you need it. Again, this option is only available on adjustable-rate HECMs.
Interest on a reverse mortgage is calculated on a monthly basis and then added to your loan balance. As with traditional mortgages, you can opt for either a fixed-rate or an adjustable-rate loan — though to get a fixed rate, you’ll need to choose the lump-sum payment option noted above. Fixed rates also tend to be higher.
Reverse mortgages do come with closing costs, mortgage insurance and other upfront expenses, but you won’t have to make any interest payments to your lender as long as you still live in the home. The balance won’t come due until you move out of the property, sell the house or pass away.
Pros and Cons of Reverse Mortgages
Taking out a reverse mortgage is a big financial decision, so it’s important to consider both the pros and cons before moving forward. Your unique financial situation and long-term goals should factor in.
See below to learn more about the pros and cons of a reverse mortgage.
Pros of reverse mortgages
There are many advantages to reverse mortgages. In the right situation, they can help support you in retirement, allow you to stay in your home longer, help you pay off your existing mortgage and even cut down on your tax bill.
That’s only when these loans are used properly, though. Here’s a look at when a reverse mortgage offers the most benefit. (We’ll go into when reverse mortgages don’t make sense further down.)
You want a tax-free way to increase cash flow.
A reverse mortgage may cut down on your tax burden in retirement. While it might feel like you’re earning “income” from the mortgage, that’s not how the IRS sees it. Instead, reverse mortgage payments are considered loan proceeds — not taxable income, so you won’t owe extra taxes come April 15.
This is different from other distributions you might take in retirement, like those from 401(k)s and traditional IRAs. With these, you’ll owe income taxes on any funds received across the year.
You plan to stay in the home for a while.
Reverse mortgages are best for homeowners who want to stay in their homes for the long haul. It gives them the chance to put their hard-earned equity to work, and it allows them to keep living in the home they love (payment-free) for an extended period of time.
Additionally, there are lots of upfront costs that come with a reverse mortgage. Staying in the property longer ensures those investments pay off — and that you stand to gain more than you spend.
You have a good amount of equity.
The more equity you have in your home, the more cash you can access via a reverse mortgage. Though you can qualify for a reverse mortgage if you are carrying a regular mortgage balance, it will significantly cut into your payments. You will be required to use your proceeds to pay the remaining loan off before you can start accessing your funds.
To truly get the most from a reverse mortgage, you’d want to own the home outright or have a very low balance on your current mortgage loan.
You’re worried the home’s value might fall.
With a HECM loan, you’ll never owe more than your home is worth. So if you think your home’s appraised value may fall in the future (all HECMs require at least one or two appraisals), a reverse mortgage could be a way to cash in on your home equity now. In some cases, proprietary reverse mortgages may offer this benefit, too, so make sure to ask your lender if you’re considering one of these.
You don’t plan to leave your house to an heir.
If your home is just a real estate asset (and you don’t have big dreams of passing it down from generation to generation), a reverse mortgage could be a good way to support your retirement.
Though loved ones can inherit properties with reverse mortgages attached to them, it complicates things. They’ll either need to pay off the lender or sell the home — not an ideal option if you want to keep the property in the family. If the home is simply an investment, though, it will be used to pay off your loan once you pass or sell the home.
You have consistent income to cover taxes, homeowners insurance and HOA costs.
Reverse mortgages are best for those with enough consistent income to cover the regular costs of homeownership. That’s because homeowners are legally required to stay current on their property taxes, home insurance and HOA dues. They also must take care of regular maintenance and upkeep, as this protects the lender’s investment. If you don’t keep up with any of the aforementioned tasks, your lender could require full repayment immediately.
Cons of reverse mortgages
Reverse mortgages aren’t perfect. They come with significant risk, and when used improperly, a reverse mortgage could lead to losing your home to foreclosure or your heirs being left with very little when you pass on. They also come with fees and could impact your ability to earn other retirement income and benefits.
When do these drawbacks come into play, exactly? Here are five scenarios when you wouldn’t want to use a reverse mortgage.
You or your heirs want to keep the property in the family.
Reverse mortgages aren’t ideal for your loved ones to inherit. While your heirs can pay off the loan out of pocket if they don’t want to sell the house, that’s probably not a decision you want to leave behind for those you loved the most.
So, if your home is one you’ve had for decades or your ancestors poured their blood, sweat and tears into, a reverse mortgage may not be the best solution.
You think you’ll move out of the home in the next few years.
Reverse mortgages come with many upfront costs. There are closing costs, origination fees, upfront mortgage insurance premiums, appraisal costs and servicing fees. The origination fee itself can go as high as $6,000 for HECMs. Altogether, it can add up to tens of thousands of dollars in some cases.
While you can use your loan proceeds to cover these costs, you want to make sure doing that is worth it — and that you’ll be around to reap the benefits. For these reasons, reverse mortgages are typically best for homeowners who are in decent health and plan to stay put for a while.
You rely on SSI or Medicaid.
Having a reverse mortgage won’t impact your Social Security payments or Medicare, but if you’re on Medicaid or Supplemental Security Income, it could reduce your benefits or even make you ineligible. That’s because these programs are means-tested — meaning your income and assets play a role in what you qualify for.
If you rely on either of these programs, you’ll want to talk to a benefits counselor or bring it up in your HECM counseling session, as every state has different rules. They can let you know if taking out a reverse mortgage would impact your SSI or Medicaid eligibility where you live.
You’re already struggling financially.
A reverse mortgage comes with both upfront and ongoing costs. If you start off the loan already struggling financially, taking on these extra costs will only exacerbate your money troubles and could even lead to foreclosure down the line.
If you’re having a hard time paying the bills, downsizing — rather than leveraging your home equity — is probably a safer bet.
You have a large balance left on your existing mortgage.
The amount of equity you have in your home plays a big role in how much money you can access through a reverse mortgage. If you have a balance left on your original mortgage loan, you’ll need to use your reverse mortgage proceeds to pay that off first, and the amount you can actually use declines.
Though it’s possible to take out a reverse mortgage when you still have a loan balance remaining, you’re better off waiting until you have more equity (ideally at least 50%). This will allow you to get the most use from your new loan.
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How do you pay back a reverse mortgage?
You need to pay back a reverse mortgage when you move out of the house (including into a care facility/nursing home for at least 12 months) or sell the house. A reverse mortgage also needs to be paid when you pass away. In the latter scenario, your estate or the person you bequeathed the property will be responsible for repaying the lender.
In the event you leave behind a non-borrowing spouse when you pass away, the loan may or may not come due. This will depend on the type of reverse mortgage you have, when you took out the loan and whether the spouse meets the eligibility requirements of the loan.
Who owns the house in a reverse mortgage?
As with other mortgage products, a reverse mortgage doesn’t impact your title; it’s simply a loan secured by the home. You still own the property, and your name is on the title and deed. The lender won’t take ownership of your home unless you fail to meet the loan’s requirements (like not paying your property taxes) or you pass away, and your heirs or estate cannot repay the balance.
Can heirs walk away from a reverse mortgage?
An heir can certainly walk away from a home that has a reverse mortgage against it. If they do, the lender will simply sell the property to pay off the balance. In the event the proceeds are not enough to repay the lender, the heir will not be responsible for the difference.
What happens to your existing mortgage with a reverse mortgage?
When you take out a reverse mortgage, your lender will require you to pay off any mortgage on the property (including your primary mortgage and any home equity loan or home equity line of credit). You can use your reverse mortgage proceeds to pay the debt off, or you can pull from savings or other assets.
What are the alternatives to a reverse mortgage?
A cash-out refinance, a home equity loan or a home equity line of credit (HELOC) can all be good options to explore if you want to tap your home equity. Cash-out refinancing replaces your existing loan with a new, larger one and gives you a lump sum of cash in return. (If you want to explore this option, check out Money’s picks for the best mortgage refinance lenders.) Home equity loans are a second mortgage, while HELOCs function like credit cards, which you can withdraw from as needed.
Summary of Money’s Reverse Mortgage Pros and Cons
Reverse mortgages can be a useful financial tool when utilized at the right time and in the right scenario. When used improperly, though, they can mean risking your house, certain government benefits and the inheritance you leave for loved ones. They can also exacerbate financial struggles for some homeowners.
If you’re considering a reverse mortgage, weigh the pros and cons carefully and consult a HECM counselor or financial advisor before moving forward.