Is a Reverse Mortgage Worth It?

They're a great fit for some homeowners, but a reverse mortgage can leave surviving family members with no equity, and sometimes no home.

A reverse mortgage turns home equity into cash -- without requiring that you move out of your home. It can be a helpful financial tool for some retirees. But before you jump in, here's what you need to know about the potential downsides.

What is a reverse mortgage?

A reverse mortgage is a loan against the equity in your home. Unlike a traditional mortgage, there is no sale of the home involved. The lender, which is the mortgage holder, does not take ownership of your home when you get a reverse mortgage. Instead, your home is used as collateral, and you get cash. The lender, however, gets a first lien on your home. That means they have the right to be paid back first when the home is sold.

You can get the cash in a few ways:

• Lump sum
• Monthly payment
• Line of credit that you can draw on
• A combination of these

You can only take a reverse mortgage against your primary residence, and this type of mortgage is only available to older homeowners who meet specific criteria.

How much can you borrow?

The amount you can borrow depends mostly on the age of the youngest borrower and how much equity you have in the home. Current mortgage rates and your other financial obligations, including any current mortgage, are also factors.

For a government-backed reverse mortgage (the most common type), the loan limit is equal to the conforming loan limit for a single family home in a high-cost area. In 2021, that limit is $822,375. Loan limits for government-backed reverse mortgages do not vary from one county to another.

When do you make payments?

Many reverse mortgage borrowers never have to make a payment. A reverse mortgage loan does not come due (it doesn't have to be repaid) until you sell the home, move, or die. If you stay in the home until you die, it will then be sold and the loan will be paid back with the proceeds of the sale. 

If you decide that you want to pay off the loan and reclaim your equity, you have the option to do that. Your heirs also have the option to keep the house after you die, either by paying off the loan or getting a new mortgage to replace it. With a government-backed reverse mortgage, if the loan balance is more than the value of the home, the price for you or your heirs to reclaim ownership is capped at 95% of the appraised value, according to the Consumer Financial Protection Bureau.

Over time, and as you access more of your equity (in the form of monthly payments or draws on your credit), your loan balance grows larger because of interest charges. To pay off the loan, you or your heirs would need to repay both the principal balance and the interest that has accrued, plus any required closing costs, just like with any other mortgage. Eventually the loan balance will be much greater than the amount of money you have received.

In many cases, repaying the loan means selling the home. Once the loan is paid off, if there is still equity, the money will be distributed to you (if you are alive) or to your estate (if you have died).

Where to get a reverse mortgage

You can get a single-purpose reverse mortgage from a state or local agency. In this case, the lender will specify that the loan can only be used for one specific purpose -- for example, to help you afford your property taxes. This type of reverse mortgage is for low- and moderate-income borrowers.

Private lenders also offer certain reverse mortgages. Those are called proprietary loans, and each lender sets its own terms and conditions. You may be able to borrow more with this kind of loan, and there are typically no restrictions on how you use the money.

Most reverse mortgages are Home Equity Conversion Mortgage (HECM) loans, which are insured by the federal government. This loan is available from FHA loan lenders. There is no restriction on how you use the money.

Potential downsides to a reverse mortgage

Here are a few factors to consider before you get a reverse mortgage:

• Variable rate: Most reverse mortgages are not fixed-rate loans. Instead, they have variable rates, like some credit cards and home equity products. The interest rate will change along with a benchmark rate that the lender has chosen to follow. Your rate can go up or down, and that is out of your control.
• Upfront costs: You'll pay an origination fee, an appraisal fee, and other closing costs, plus mortgage insurance premiums. You may be able to roll these costs into the loan balance, but in that case, you'll start on day one owing a considerable amount of money.
• Other expenses: A reverse mortgage is a loan, not a sale. You'll still be the homeowner, and that means you are responsible for all utilities, maintenance, property taxes, insurance, and other homeownership costs.
• No tax benefit: Generally, the interest on a reverse mortgage is not tax deductible.
• Loan limits: Government-backed loans are subject to current loan limits. Plus, lenders set their own limits -- they won't loan you 100% of your equity. That's because the eventual sale price needs to cover interest and loan costs.

Potential upsides to a reverse mortgage

Having regular monthly income in old age is a benefit. Reverse mortgages allow you to access what might be your largest asset -- the equity in your home -- which would otherwise be virtually untouchable. After all, everybody has to live somewhere. Unless you're willing to live life in an RV, you probably won't sell your home and put the cash in your checking account. Plus, if you did, you might open up a can of tax worms. A reverse mortgage helps you get that cash without negative tax consequences (it's not taxable).

If your retirement income is too low to cover all of your financial obligations, a reverse mortgage could help you afford to stay in your home by providing you with funds to pay your property taxes and maintenance expenses. 

Some financial planners consider a reverse mortgage to be a good strategy for maximizing assets that you can leave to your heirs. The reasoning is that money you withdraw from some retirement accounts is taxed as income. On the other hand, the money you receive from a reverse mortgage is not taxable. So if you can live on reverse mortgage proceeds and preserve your retirement savings, you might end up leaving more money to your heirs.

Finally, if leaving your home to someone after you die is not a priority for you, a reverse mortgage is a good way to get the full benefit of your home equity while you are still living.

When a reverse mortgage might be a bad idea

Here are a few scenarios when getting a reverse mortgage might not be the best choice.

Young borrowers

Relatively young homeowners should make the decision to get a reverse mortgage carefully. You have to be at least 62 to qualify, but even that may be too young if you want a long-term stream of income. It's possible to max out your proceeds with certain types of reverse mortgages (such as a line of credit or a term payment plan with a predetermined stop date). You won't be forced out of the home, but you will stop receiving money.

High emotional value on the home

A reverse mortgage may be a bad idea if leaving a paid-off home to your heirs is important to you. The loan balance, including interest, could leave them little to nothing to inherit from this particular asset.

Married borrowers applying alone

It might not be a good idea to get a reverse mortgage as a sole borrower if you are married. Older homeowners may be tempted to apply alone because they can often qualify for a bigger loan without the younger spouse. But understand the limitations.  

If the loan is an HECM, a qualified surviving spouse can remain in the home, but the lender won't release any more money. To qualify to stay in the home, the spouses must have been married when the loan was signed and satisfy other criteria. 

If the surviving spouse is allowed to stay in the home, the loan won't have to be paid back until they move, sell, or die. But for other types of reverse mortgage loans (not HECM), the lender might be allowed to call the loan due on the borrower's death, forcing the surviving spouse to move.

Other adults unprotected

Other adults in the home are generally not protected. Adult children or other household members will need to either repay the loan or move when the borrower dies.

Loan proceeds insufficient

Lastly, if there's a chance you or your surviving spouse will struggle financially, even with the loan, a reverse mortgage could be a risky move. You'll still be responsible for property taxes, homeowners insurance, and other expenses. If you don't keep up, you could lose your home.

Who should get a reverse mortgage?

A reverse mortgage can help you turn your biggest financial asset into a monthly income. If these criteria apply to you, a reverse mortgage might be a viable option:

• You have a lot of equity in your home or it is paid off
• You want or need more money every month
• You don't expect to have a financial hardship if you max out your proceeds before you die
• You want to preserve your retirement account balances

Reverse mortgages have their value, in the right circumstances. Just be sure to research how a reverse mortgage will affect your finances -- and your family -- before you sign on the dotted line.