Many seniors are struggling financially. If you're one of them, you may be considering a reverse mortgage. But what is a reverse mortgage, and how does it work? We'll walk you through this complex financial product and review its pros and cons by answering the most common questions people have about reverse mortgages.
What is a reverse mortgage?
If you own a home, you're probably familiar with traditional mortgage loans. You borrow money to finance the purchase of your home, and in return, you make a monthly mortgage payment to your lender until your home loan balance is paid off.
A reverse mortgage works the opposite way. With a reverse mortgage, you get paid a certain sum based on the equity you have in your home. In fact, reverse mortgages are also known as home equity conversion mortgages, or HECMs, because when you take one out, you convert your home equity into an income source. Another way to think of it is that when you're in the process of paying off a regular mortgage, you gain equity in your home over time. With a reverse mortgage, you're effectively giving away that equity.
Who's eligible for a reverse mortgage?
There are certain criteria you'll need to meet to qualify for a reverse mortgage. You must:
- Be at least 62 years old.
- Have sufficient equity in your home (often, you'll need to own your home outright).
- Live in the home as your primary residence.
- Have a home that meets HUD standards -- meaning you own either a single-family home or a two- to four-unit home where one unit is owner-occupied.
- Not be delinquent on federal debt.
- Participate in a HUD-approved counseling session, where you gather information about what reverse mortgages entail.
Additionally, to get a reverse mortgage, you must stay current on your property taxes, keep paying your homeowners insurance, and make any HOA payments you're liable for. You’re also required to keep up with home maintenance.
How does a reverse mortgage pay me?
You have several options for getting paid with a reverse mortgage. You can receive:
- Equal monthly payments for as long as you continue to live in your home.
- Equal payments over a preset number of months.
- A combination of the above two options.
- A line of credit you can draw against.
- A combination of fixed monthly payments and a line of credit, either for as long as you live in your home or for a preset number of months.
You may also be eligible to receive a single lump-sum payment instead of monthly payments.
Ultimately, the amount of money you're able to get via a reverse mortgage will depend on your age, current interest rates, and the market value of your home. There's also a limit as to how much a reverse mortgage can pay you. That limit has increased steadily over the last four years, reaching $765,600 in 2020.
What are the benefits of a reverse mortgage?
The primary benefit of a reverse mortgage is getting access to the money you need without having to go through the motions of applying for a personal loan and paying hefty interest on it (keeping in mind that you may not get approved if your credit isn't great). Qualifying for a reverse mortgage is fairly easy, provided you meet the above criteria, and the money you borrow with a reverse mortgage doesn't need to be repaid until you either pass away, move out of your home, or sell your home. Additionally, the funds you receive from your reverse mortgage aren't considered taxable income, and they won't impact your Social Security benefits.
What are the drawbacks of a reverse mortgage?
Though there are benefits associated with a reverse mortgage, do keep in mind that the drawbacks are substantial enough to outweigh them. For one thing, you'll typically pay high closing costs for a reverse mortgage. Additionally, while a reverse mortgage will give you access to some money, it won't necessarily make your home more affordable. If you're grappling with high maintenance costs and paying a lot of property taxes, you might continue to struggle financially even with that extra money since you'll still be the one liable for those peripheral costs of homeownership.
Furthermore, a reverse mortgage is a loan and you're responsible for repaying it. You can do so by selling your home, but then you'll have nowhere to live and will be unable to leave your home to your heirs. If you don't repay the loan during your lifetime, it will come due upon your passing. If that happens, and your heirs can't settle its balance, they may be forced to sell the home you leave them to fulfill that debt.
It's also worth mentioning that in recent years, the reverse mortgage industry appears to have resorted to predatory tactics. In fact, a 2019 USA Today investigation found that close to 100,000 reverse mortgages -- many of which originated in low-income urban areas as a result of aggressive door-to-door sales -- had defaulted in recent years. Many seniors sign up for reverse mortgages without really understanding what they’re getting into and ultimately regret it.
How do reverse mortgages compare to borrowing against my home?
Though a reverse mortgage is a good way to use your home to access money, another less risky option to consider in this regard is to borrow against your home. You can do so via a home equity loan or a home equity line of credit, or HELOC.
With a home equity loan, you borrow a lump sum and pay it back over time, with interest. With a HELOC, you get access to a specific sum of money you can draw from as needed, at which point you only pay back the amount you actually borrow.
With a home equity loan, you'll generally need to start repaying the amount you borrow shortly after you borrow it. With a reverse mortgage, you don't owe any money until you die or vacate your home. But with a home equity loan or HELOC, the criteria aren't as strict -- you can qualify for them at any age, provided the equity in your home is there.
Should I get a reverse mortgage?
Reverse mortgages might seem like a great deal, but they're not right for everyone. If you can't keep up with the costs of owning your home, then they're not a helpful solution. And if you pass away unexpectedly, your loved ones who inherit your home may find themselves stuck in a tough financial spot when that loan immediately becomes due.
But if you don’t have heirs to leave your property to, then a reverse mortgage may not be such a bad idea. If you're okay with your home being sold upon your passing to pay off your mortgage, then this option might be worth looking into.
If you're going to get a reverse mortgage, make sure you understand exactly what you're signing up for, and review the costs involved. You may find that there's a better solution for accessing money that doesn't entail the same risks as a reverse mortgage.
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