Reverse Mortgages: Understanding the Pros and Cons

A reverse mortgage is a type of consumer home loan that allows homeowners ages 62 and older to borrow against their home’s equity to receive either cash or a line of credit. 

Unlike a traditional mortgage, homeowners don’t make a monthly payment; the loan is repaid when the homeowner or their heirs sell the house. 

Senior homeowners often use a reverse mortgage to minimize their monthly housing costs and have access to liquid assets like cash during their retirement. 

How a Reverse Mortgage Works

The most common type of reverse mortgage is a home equity conversion mortgage (HECM), which is a federally backed loan regulated by the Federal Housing Administration (FHA) and the U.S. Department of Housing and Urban Development.

To qualify for an HECM you must: 

• Be 62 years of age or older
• Have no outstanding federal debt such as unpaid income taxes
• Own your home outright or have significant equity in the home (usually 50% or more)
• Have at least one homeowner live in the residence most of the year
• Be current on property taxes, homeowners insurance, and HOA fees
• Go through a credit check and meet other eligibility requirements
• Attend HUD-approved financial counseling 

With a traditional mortgage loan, a homeowner pays the lender back with interest over time in the form of monthly payments. With a reverse mortgage, the lender agrees to make payments to the homeowner based on a percentage of equity that’s been built in the home. The homeowner may receive a lump sum, monthly payments, a line of credit, or a combination of any of those methods. 

Interest, fees, and other costs associated with the loan are rolled into the monthly payments, meaning the amount of the loan increases over time. The loan is repaid when the homeowner sells the home or dies, and proceeds from the sale of the home are used to pay off the debt. 

Heirs or the estate are not liable for the difference if the loan is worth more than the value of the house at the time of sale. Heirs who choose to keep the property may consider paying off the reverse mortgage and refinancing to a more traditional mortgage. 

Pro and Cons of a Reverse Mortgage

As with any major decision that affects your finances and potentially your quality of life, consider the pros and cons of undertaking a reverse mortgage, and make sure you talk extensively with your lender to understand the nuances and conditions of your specific loan. 

Pros: 

• You’ll continue to live in your home: Instead of selling your home in order to liquify your asset for cash, you’ll retain the title to your property and live there provided you stay current with property taxes, homeowners insurance, and maintenance. 

• Helps to shore up your retirement funds: A reverse mortgage can be beneficial for retirees who may not have enough savings or investments for retirement, but have a high amount of equity built up in their homes. A reverse mortgage allows seniors to turn an illiquid asset into cash without selling it outright.

• No tax liability: The proceeds of the loan are generally considered by the IRS to be an advance rather than income, which means you receive the proceeds of the loan as tax-free cash to do what you wish with. Consider speaking with a financial professional about your specific situation. 

• No monthly payments: Your home doesn’t need to be paid off in full in order to qualify for a reverse mortgage. Many retirees choose to pay off their existing traditional mortgages with a portion of proceeds from the reverse mortgage. And because you’re not making monthly mortgage payments with a reverse loan, you’ll free up money to use for other expenses. 

• You and your heirs are protected: If the value of your home turns out to be less than what’s owed on the balance of the reverse mortgage, neither you nor your heirs are held liable for the difference when the home is sold. This can provide peace of mind for some seniors knowing they or their heirs are not on the hook should home prices dip, for example. 

Cons:  

• Less for your heirs to inherit: A reverse mortgage may eat into the wealth you hope to pass down to your heirs, as they’ll be required to pay off the loan or 95% of the home's appraised value to the lender, whichever is less. Meeting this requirement usually entails selling the home to cover the debt. Any equity remaining in the home — if there is any —  goes back into the estate to be distributed among the heirs. 

• Fees and expenses: Reverse mortgages are not free money. Homeowners are still responsible for property taxes, homeowners insurance, and maintenance and upkeep, and run the risk of foreclosure if they’re not able to keep up with those expenses. In addition, there is an origination fee, monthly servicing costs, closing costs, and interest, which can be rolled into the loan balance, but you’ll receive less money. 

• Impact on other retirement benefits: While a reverse mortgage is not considered income or taxed, it could have an impact on other government benefits like Medicaid or Supplemental Security Income (SSI). Be sure to go over your options with a professional to understand the potential effects a reverse mortgage could have on your situation. 

If you feel like a reverse mortgage might not be the right choice for you, there are alternatives. You could consider refinancing your existing mortgage for a better rate or a cash-out refinance. A home equity loan, like some reverse mortgages, can be paid out in a lump sum, but unlike a reverse mortgage, must be paid back on a monthly basis. 

Many homeowners decide the best way to access the equity they’ve built is to sell their home and move. They may use the proceeds from the sale to downsize to a property with less maintenance and fewer taxes. 

Ultimately, the key to deciding whether a reverse mortgage is a good idea for you and your situation is to consult a professional to help you understand the risks and terms associated with the loan you’re considering.