As people approach retirement, many wonder if they can supplement their income. There are many ways to generate funds, but one often overlooked financial tool is a reverse mortgage. Many consumers and even some financial planners don’t completely understand how they work or the pros and cons of a reverse mortgage. Here is a look at the advantages and disadvantages of these loans.
Overview of a Reverse Mortgage
These mortgages are typically designed specifically for homeowners 62 and older and allow you to convert part of your home’s equity into cash without having to sell your property. You also don’t have to make any monthly mortgage payments. Instead, the lender pays you.
As good as that sounds, you need to understand that borrowers must meet all loan obligations. This includes living in the property as the principal residence and paying property charges, including property taxes, fees, and hazard insurance. The borrower must also maintain the home. If the homeowner does not meet these loan obligations, the loan will need to be repaid.
As with any financial decision, you want to be as informed as possible before applying for a reverse mortgage. To jump-start your research, here’s a list of the pros and cons of a reverse mortgage, along with some other valuable insights that can help you quickly determine whether a reverse mortgage could be the solution that’s right for you.
Types of Reverse Mortgages
There are three basic types of reverse mortgages, and each has its unique benefits. The main types are:
- Home Equity Conversion Mortgage (HECM). These are federally insured by the Federal Housing Administration (FHA), which is part of the U. S. Department of Housing and Urban Development (HUD).
- Single-purpose reverse mortgage. These loans are offered by some state and local government agencies, as well as non-profit organizations. They can be a good choice for homeowners with low- to moderate-income.
- Proprietary reverse mortgage. These private loans are backed only by the companies that develop them. If you own a higher-valued home, you can often get a bigger loan through this type of reverse mortgage.
Pros of a Reverse Mortgage
Reverse mortgages offer borrowers a wide range of benefits. Here are some advantages worth considering:
- You are still the owner of your house. You retain the title to your home and, as long as you meet the loan obligations, you can continue to live there. As the owner, you can also bequeath your home to whomever you wish. Taking out a reverse mortgage doesn’t mean your home belongs to the bank.
- Safeguards are in place to protect consumers. The National Reverse Mortgage Lenders Association requires that their lender members commit to a code of ethics and operate responsibly.
- A fixed-rate reverse mortgage keeps the same rate throughout the term of the loan. This can help protect you from market fluctuations.
- You don’t have to worry about monthly mortgage payments. The only payment you’re required to make is due in full when you sell your home, pass away, or fail to meet your loan obligations. Of course, you will still need to pay for homeowner’s insurance, taxes, home maintenance, and other fees outlined in the terms of the loan. Otherwise, you must repay the loan.
- There are no prepayment penalties. If you want to repay the loan, you are free to do so.
- A reverse mortgage is considered a non-recourse loan. Should you sell your home at the appraised fair market value, and that sale price is less than what you owe on your reverse mortgage, neither you nor your heirs are personally responsible for paying the remaining loan balance. Instead, the FHA mortgage insurance will pay the difference.
- If you need to sell your home, you’re free to do so. You’ll be required to pay off the loan with proceeds from your sale.
- The application process is easy. It’s very similar to a traditional mortgage application. However, if you want to apply for a HECM, there is an extra step. You’ll need to attend a financial counseling session with a HUD-approved counseling agency to ensure you understand the loan terms, your obligations, and options.
Cons of Reverse Mortgages
Even though there are clear advantages to a reverse mortgage, the reality is they aren’t the right solution for every borrower. Here are the downsides you need to consider:
Not everyone can apply for a reverse mortgage. Here are the basic general requirements:
- You must typically be 62 years old or older
- You must be listed as the owner on your home’s title
- Your income and credit must clear a financial review
You can be considered in default on your loan, and the balance will be due immediately if you fail to meet all loan obligations, including but not limited to:
- Failure to pay your property taxes, homeowner’s insurance, or flood and hazard insurance
- The property becomes run down, and repairs are not made
- Abandonment or donation of the home
- Failure to occupy the property as a principal residence
Not every property qualifies for a reverse mortgage. For instance, vacation homes and rental properties do not qualify.
How a Reverse Mortgage Fits into the Financial Planning Process
As you plan for your retirement, here are some examples of how a reverse mortgage can give you financial flexibility and peace of mind.
- A reverse mortgage is commonly used to restore depleted savings or supplement income. It can also help you pay for medical expenses or long-term care.
- Not having to pay monthly mortgage payments means increased cash flow.
- You can often choose how you’d like to receive your proceeds. You can take your funds as a lump sum to help pay off a large debt, a line of credit you can draw from over time, or as monthly payments for a steady inflow of cash. You can also choose a combination of these options.
If you think this type of loan could be right for you, understanding the pros and cons of a reverse mortgage is an important first step. As always, it’s wise to consult with a financial advisor as you plan for your retirement.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.