In general, Americans are not very good at managing debt in preparation for retirement. According to the New York Times, households headed by someone over the age of 55 with debt increased to 68.4% in 2019, up from 53.8% in 1992. Part of this debt is due to credit cards, student loans, and medical bills. Enter reverse mortgage.
About 1 million reverse mortgages have been underwritten for qualifying homeowners since the alternative financial planning strategy became available in 1961. In this article, we explore what this loan is, along with some pros and cons.
What Is a Reverse Mortgage?
A reverse mortgage is a type of home loan.
With a traditional mortgage, you pay a lender — in the form of principal plus interest — every month to buy your home over a specified time period.
- Mortgages are usually offered in 15 or 30-year terms.
- If you’ve ever looked at a mortgage loan amortization schedule (which a lender is required to give you), you may have noticed that during the first half of a traditional loan, most of your payment is allocated to interest.
- In the latter half of your loan, more of your payment is paying down the principal and building your ownership of the property, called equity.
- As you near the end of your mortgage loan term, you’ve built up significant equity.
A reverse mortgage takes part of the home equity you’ve built over the years and converts it into payments to you. Instead of paying down your loan by making a regular payment, you are receiving a lump sum or regular payments from a lender. This increases your loan as you cash out your paid-up equity. Essentially, you are borrowing from the equity in your home to pay yourself.
How Does a Reverse Mortgage Work?
When you take out a reverse mortgage, you are opting to receive a portion of your home’s equity to spend as you please.
In exchange, you agree to:
- Pay property taxes and homeowner’s insurance
- Live in the home as your primary residence
- Keep the home in good repair.
The loan becomes due, in full, when you:
- Decide to sell or pass away
- Vacate the home for more than 12 consecutive months
- Fail to pay taxes, insurance or maintain the home.
Many reverse mortgage lenders allow you to make payments any time as you continue to live in the home. When you decide to move and sell, the loan will be fully due and the amount of principal and interest you’ve accrued will be deducted from your proceeds at closing.
Three Types of Reverse Mortgages:
- Single-purpose: These are offered by nonprofits and some state and local government agencies. They’re designated for a specific purpose, such as a home remodel or expensive repair.
- Home Equity Conversion Mortgages (HECMs): A reverse mortgage offered by for-profit companies and federally insured with varying fees.
- Proprietary: Offered by private individuals and frequently have greater term flexibility, but potentially more expensive.
Who Is a Reverse Mortgage Best Suited For?
For most retirees, their home is their greatest retirement asset. A reverse mortgage allows senior homeowners — you have to be 62 years of age or older to qualify — access to their home’s equity for retirement expenses, while still retaining ownership and possession of the home itself.
To be eligible for a reverse mortgage, you need to meet all four of these criteria:
- Be at least 62 years of age.
- Own your own home.
- Have sufficient equity in your home to borrow against. You don’t have to wait until your home is completely paid off to get a reverse mortgage.
- Live in the home as your primary residence.
Even if you are qualified, a this loan might not be the best solution for your financial needs. Before committing, you should consult with an independent reverse mortgage counselor.
The United States Department of Housing and Urban Development (HUD) provides this free counseling and you can find a counselor near you by searching the HECM Counselor Roster or calling (800) 569-4287. You can also look for a nationwide counselor using the HUD Intermediaries Providing HECM Counseling Nationwide list.
Who Are the Reverse Mortgage Lenders?
Not all lending institutions provide reverse mortgages. Your local bank branch manager is unlikely to be your best source to inquire about getting a loan. However, there are national and local companies that specialize in — and understand the unique nuances of — reverse mortgages. You should compare and contrast the offers and terms of several lenders. Carefully consider your specific needs before choosing one.
How Much Can You Borrow?
The amount of money you can borrow depends on how much home equity you have. You can typically borrow up to 80% of your home’s equity based on its appraised value. As of 2021, the maximum amount anyone can be paid from a reverse mortgage is $822,375. To figure out how much you could borrow, you can use this calculator.
Pros and Cons of Reverse Mortgages
- You can continue to own and live in your home, as long as you carry homeowners insurance, make property tax payments, and maintain the home.
- You can access the equity you’ve built in your home to use for other purposes, including retirement expenses.
- There are no monthly mortgage payments.
- 100% of the loan repayment is deferred until the homeowner sells the home, dies or moves out (a reverse mortgage is only available on a primary residence).
- Payments are tax-free.
- You choose your payment disbursement option. The proceeds of the loan can be paid out as a lump sum, or regular monthly payments.
- Homeowners are responsible for paying property taxes, insurance, and maintenance. If you default on tax payments, you could lose the home to foreclosure.
- Since you are essentially living off the built-up equity in your home, there will be less for your heirs to inherit.
- Like any mortgage refinance, there’s a high cost associated with getting a reverse mortgage. This can include closing costs, associated admin fees, loan origination fees, and other lender charges.
- The loan balance increases over time as payments are made to you and interest on the total amount borrowed increases.
Can You Use Reverse Mortgages to Invest?
You can, but using a reverse mortgage to access investment funds allows limited utility at a high expense. You would have to qualify for a reverse mortgage by meeting the criteria listed above. It’s crucial to calculate the cost of borrowing the money. In addition to paying closing costs when you get a reverse mortgage, lenders typically charge an origination fee and annual service fees.
Whatever you choose to invest in with these borrowed funds would need to be very low-risk. And it would need to provide income over and above the interest rate and loan fees. Since most high reward investments also carry a high risk, in most cases it doesn’t make sense to use the funds from a reverse mortgage to invest.
Can You Use a Reverse Mortgage to Pay Off Other Debts?
If you’re considering a reverse mortgage to consolidate other high-interest debt, consider the costs of acquiring and maintaining the reverse mortgage. Then calculate how much, if anything, you will save over time. If you have a lot of high-interest consumer debt at age 62, you should explore all your options with a qualified financial planner.
Is It Safe? How to Avoid Scams and Frauds
Before pursuing a lender, consult with an independent qualified financial counselor to understand if a reverse mortgage is a right solution for you. Some home improvement salespeople suggest that a reverse mortgage is an easy way to pay for home improvements. While this is possible, it’s unlikely to be your best option given the costs of getting the loan.
Use caution if a reverse mortgage lender is pressuring you. Make sure you know everything about the options and terms they are offering. Remember that a loan officer’s job is to get business for their company. So they are understandably incentivized to emphasize the pros and gloss over the cons. While a reverse mortgage is a powerful wealth management tool, it’s not necessarily the best solution for every homeowner or retiree.
Final Thoughts: Is a Reverse Mortgage a Good Idea?
For the right situation, a reverse mortgage can be a powerful financial planning tool. Homeowners typically use them to increase retirement cash flow when they want to “age in place.” By eliminating a mortgage payment and assessing the equity, a homeowner can increase their financial resources.
A reverse mortgage is not right for everyone. It’s important to weigh the benefits and drawbacks when considering if it’s right for you, or your aging parents. A very important first step is to speak with an independent reverse mortgage counselor and explore if a this is the best option for you.