A reverse mortgage is a loan that allows homeowners to convert part of the equity in their property into cash. No monthly principal or interest payments are due as long as you live in the home and meet all loan obligations.
However, the cost can be prohibitive. Before agreeing to a reverse mortgage, keep these factors in mind.
Versions of reverse mortgages
Not all reverse mortgages are the same. In fact, there are several versions, and each operates in its own way.
- Home equity conversion mortgage (HECM): The version insured by the Federal Housing Administration (FHA) and the most common type of reverse mortgage.
- Proprietary reverse mortgage: Offered by private lenders without federal insurance. This version is typically intended for homes valued above the insured program's coverage limit.
- Single-purpose reverse mortgage: Offered by some states, government agencies, and nonprofit organizations for specific purposes, such as paying property taxes or making home repairs.
Factors worth considering
No matter which type of reverse mortgage you're most interested in, you may want to consider these issues:
- Your long-term housing plan: If you think there's a chance that you'll be moving within a few years, a reverse mortgage can be extremely costly, particularly due to high upfront fees.
- Your ability to maintain ongoing obligations: You may find yourself having to withdraw more from your IRA or other retirement account than expected to cover the cost of homeowners' insurance, property taxes, and basic annual maintenance issues.
- Impact on your heirs and estate: A reverse mortgage will likely mean that your heirs will receive less home equity once the loan and associated costs are settled. Whether or not your current estate plan includes leaving the home to heirs, it's an important point to keep in mind.
- Effect on means-tested programs: Although reverse mortgage proceeds aren't counted as taxable income, they may be counted as assets for means-tested programs -- such as Medicaid, Supplemental Security Income (SSI), or SNAP benefits -- once deposited in your account.
Downside of a reverse mortgage
While a reverse mortgage may work out beautifully, this type of loan is not without cons, including:
- Growing debt: Interest and fees are added to your balance each month, increasing your debt as your home equity shrinks over time.
- High costs: Between high upfront costs and ongoing expenses, reverse mortgages are an expensive way to borrow money.
- Risk of foreclosure: After taking out a reverse mortgage, you must continue to pay property taxes and homeowners' insurance, and maintain the home. Failure to do so can trigger default and foreclosure.
Alternative options
Before making a final decision, an independent financial advisor can help you work through alternative options. For example, if you need extra cash, compare options such as refinancing, a home equity line of credit, trimming existing expenses, using government assistance programs, or downsizing.
After years spent planning for everything from healthcare expenses to taxes in retirement, you owe it to yourself to compare all options.
