Image source: XXXXXX. 

A reverse mortgage can be an excellent way for retirees to increase their income, or to get extra cash for a large purchase or unexpected expenses. However, a reverse mortgage is a major financial decision and should not be taken lightly. If you're considering a reverse mortgage, here are three smart things to do before you apply.

Compare it with your other options

Reverse mortgages aren't cheap. Just like traditional mortgages, reverse mortgages have closing costs and other origination expenses. In fact, according to the National Association of Reverse Mortgage Lenders, the average FHA-backed $100,000 reverse mortgage comes with more than $8,900 in closing costs and other fees.

Don't get me wrong -- there are definitely some advantages that come with reverse mortgages, with the biggest advantage being that it's the only type of borrowing you're likely to find that doesn't require you to make any payments. However, other loan options may be considerably cheaper.

For instance, as I write this, you can obtain a home equity line of credit (HELOC) with an interest rate of less than 4.5% with no origination fees whatsoever. Of course, you'll need to make monthly loan payments, but the point is that it's a much cheaper way to borrow money if you just need a lump sum for a big purchase. Obviously, if you want a reverse mortgage with annuity-like payments, this won't do.

Shop around

Just like a traditional mortgage, reverse mortgage lenders can offer different interest rates for the exact same loan. One common mistake people make when shopping for any type of mortgage is assuming that either all lenders offer the same interest rates, or that small differences in interest rates don't matter.

To illustrate this, consider the following example. Let's say that you want to take out a $100,000 lump sum reverse mortgage, and you are given two offers. Both have the same closing costs, but one has an interest rate of 5% while the other has an interest rate of 4.75%. These sound similar, right?

Well, after 10 years, the lower interest rate translates to interest savings of $3,837. After 20 years, it's more than $12,000. That's $12,000 more in home equity that you'll retain to leave to your heirs. I'd say that's worth the time it takes to shop around.

Understand what you're getting into

Finally, just like every other major financial decision, one of the smartest things you can do is to educate yourself as much as possible about reverse mortgages before you apply. Just to name a few things you should know about this type of loan:

  • Reverse mortgages are available in a lump sum payment, a series of monthly payments either for a set amount of time or for the rest of your life, a line of credit, or as some combination of these options.
  • Not everyone can obtain a reverse mortgage. You generally have to be at least 62, have enough equity in your home to justify the reverse mortgage, and own a type of home that meets HUD standards.
  • Reverse mortgages don't have to be paid back until the borrower dies, or until the home is sold or vacated.
  • Reverse mortgages require the borrower to pay mortgage insurance.
  • Unlike a traditional mortgage, reverse mortgage borrowers are still responsible for paying property taxes and insurance every year. Depending on your financial condition and credit history, you may be required to leave some of the reverse mortgage's proceeds in escrow for this purpose.
  • Reverse mortgages usually have a non-recourse clause, which means that no matter what your interest rate is, how much you receive, or how long your loan remains outstanding, you can never owe more than the sale price of your home.

This isn't meant to be an exhaustive list, and you can read a more comprehensive overview of reverse mortgages here. The point is that the more you know and understand about reverse mortgages, the better-equipped you'll be to make a wise decision when shopping for yours.