Home equity has served as a very important source of cash for millions of retirees over the generations. One method to access that money without having to sell the property is with a reverse mortgage -- something that makes sense for a lot of older Americans who need extra money to make ends meet but also want to stay in their current home.
Is a reverse mortgage right for you? It could be, depending on a number of factors, but it could also be a bad idea if you don't know the repercussions or consider all your other options. Let's take a closer look at three frequently asked reverse mortgage questions. The answers to these questions can help you decide if a reverse mortgage is right for you.
How does a reverse mortgage work?
In short, it's a kind of loan, with your property as the collateral. Depending on how it is structured, you may be paid the total amount of the loan in a lump sum, in regular monthly payments, or as a line of credit you can access as you need it.
But where a reverse mortgage differs from a conventional loan is how you pay it back. Unlike the regular monthly payments you make on most loans, a reverse mortgage doesn't have to be repaid until either your death, you want to sell or move out of your home, or fail to meet some other requirement, such as maintaining the property or keeping up with taxes or other expenses.
However, the loan will begin accruing interest as soon as you receive money from it, and the longer the reverse mortgage remains unpaid, the more that interest will add up and have to be repaid at some point, versus a mortgage or home equity loan with a payment schedule that reduces the balance each month.
Does a reverse mortgage make sense for you?
This depends on multiple things, and every individual and situation is unique. Here are two things that indicate a reverse mortgage may make sense for you:
- If you own your home or have a low mortgage balance that could be paid off with the proceeds from the reverse mortgage with sufficient equity remaining to meet your needs
- If you plan to stay in your home
- You don't own other assets that may serve as a better source of cash, and without the potential additional costs of a reverse mortgage, or the additional cost doesn't justify selling those other assets first
The third bullet is particularly worth exploring. If, for instance, you could tap a reverse mortgage to make accessibility improvements, cover expenses such as property tax, or in some other way ensure your ability to stay in place longer, that could be an ideal use of a reverse mortgage. Furthermore, the fact that a reverse mortgage doesn't have to be paid back as long as you are living in the residence could make it an ideal source of cash later in life.
So the bottom line is, if your primary goal is to access cash that will allow you to stay in your home for as long as possible, a reverse mortgage could be the best way to do so.
What are the alternatives to a reverse mortgage?
The three biggest negatives to a reverse mortgage are the costs, loss of flexibility regarding the property, and the potential complication if your intention is to leave your home to your family. Because of this, it's important to weigh your options carefully.
With regards to cost, the upside of not having to repay the loan while you reside in your home comes at the expense of interest and closing costs. If your long-term plan isn't to remain in your home or your health could make it less likely than you want, the equity you lose when you repay the reverse mortgage will leave you with less money than you would have had otherwise.
Because of this reality for many people, it's important to weigh the expense of a reverse mortgage versus alternatives.
Selling your home and downsizing. There are actually two benefits to making this move:
- Access to the excess home equity after buying a less expensive smaller home
- Lower expenses, including taxes, utilities, maintenance, and insurance, leaving you with more disposable income
Think about it this way: Is it more important to stay in your current home, or is the real goal to continue living on your own? If it's the second, downsizing could be a better way to accomplish your real goal.
A home equity loan. If you want to stay in your home, but the financial need is short term in nature or for a one-time event, such as home repairs or accessibility updates, it could make more sense to use a traditional home equity line of credit or loan. You will have to start making payments immediately with a home equity loan, but the loan balance will start to fall with each payment while a reverse mortgage balance goes up every month as interest accrues.
As long as the payment wouldn't create a hardship, a home equity loan could also be a better choice in terms of flexibility down the road. If your long-term plans are still unsure in terms of staying in your home or whether you intend to leave your home to your family at your death, a home equity loan may be a better way to go.