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What is a Reverse Morgage?
If you have a normal
mortgage, you’re making monthly payments to a lender. But with a
reverse mortgage, the lender pays you. For many people, a reverse
mortgage can be a very appealing source of retirement income. But
there are drawbacks as well as benefits. Below are the
Cons of a Reverse Mortgage.
PROS of a Reverse Mortgage
Access home equity. You are able to access your home equity, likely a substantial portion of your wealth, without having to leave your home.
Remain in your home. As long as you keep your loan in good standing, you may remain in the home for as long as you live.
Defer payments. You can defer payments until you leave the home or pass away.
Flexibility. The Home Equity Conversion Mortgage (HECM) program is extremely flexible in terms of withdrawing the proceeds of your loan.
Line of credit. HECM’s credit line option can be incredibly attractive, as an unused credit line will grow over time.
Pay off debt. It can be useful for paying off a mortgage or expensive consumer debt.
Limit on what you owe. Neither you nor your heirs will ever owe more than the home is worth.
In fact, you don’t have to pay the loan back at all until you die, or until you move out of your home. This means the loan is either paid for through the money you leave behind or through the proceeds you get when you sell the home. This can make the debt burden feel much lighter for retirees.
You do have to be at least 62 to qualify for a reverse mortgage. But there are no income restrictions, and the income is tax-free.
CONS of a Reverse Mortgage
Can be expensive. Though closing costs are typically financing into the loan, you may end up using up between $5,000 to $10,000 of your home equity immediately.
Choices to make with complex tradeoffs. Though you will have help from a HECM counselor and hopefully other advisors, you will need to make a complicated decision.
Use up your home equity. In many cases, you will end up using up a large portion of your home equity, both in the cash you withdraw and the interest that accrues over time. This will leave you with less wealth moving forward, and it will reduce the inheritance that you can leave.
Move out and the loan becomes due. If you need to stay in a nursing home or an assisted living facility for over a year, the loan becomes due.
Risk of foreclosure. Borrowers who do not keep the house in good repair or fall behind on tax and insurance payments face the risk of foreclosure.
HECM Risks and Disadvantages
The Consumer Financial Protection Bureau identified five key risks to obtaining a HECM loan. These risks are covered in more detail on other pages of this website, but this should give you a strong foundation of what could go wrong.
As you can see there are some pros and cons to getting a reverse mortgage so make sure a reverse mortgage is right for you.
The key risks are:
Moving becomes difficult. A senior may eventually need to move out of the home, even if this is not his or her preference. This often occurs due to health reasons when the senior must enter a nursing home, assisted living facility, or to move in with a family member who will become a caregiver. Other times, it is because the senior can no longer afford to pay for taxes, insurance, and basic maintenance. By that time, the senior may have no home equity left to finance the move. This risk is especially severe for borrowers in their 60s.
Postponing the inevitable. For many seniors who have limited savings and retirement funds, using a HECM simply postpones the inevitable – needing to leave the home – while eating away valuable home equity.
Ignoring better options. Some seniors would be better served using a HELOC or a traditional home loan for short term cash needs.
Bad investments. Those who take a large lump sum are at risk of reinvesting the money at a lesser return than the interest on the HECM. These seniors are also a more likely target for fraud and various scams.
Problems for family. Anyone who lives in a senior’s home that is not named on a reverse loan will need to either move or pay off the loan when the borrower dies or moves out of the residence. Many borrowers and their family members do not understand this risk and do not adequately prepare. In fact, this very issue has made the news when a non-borrowing spouse was forced to move following the death of a borrowing spouse.
Unique Benefits of Reverse Mortgages
That said, there are very attractive features to a HECM, especially if the borrower chooses the line of credit option to withdraw his or her funds. In an article in the Journal of Financial Planning, financial planners John Salter, Shawn Pfeiffer, and Harold Evensky identify the following benefits to taking out a reverse mortgage, most of which come down to flexibility:
Credit line. The borrower has full control over use of the line of credit, deciding when, and even if, it gets used.
Flexibility. The borrower may choose to pay back the loan at any time to preserve home equity or never pay back the loan as long as the senior remains in the home.
Tax benefits. The proceeds of a reverse mortgage are tax-free, and if the borrower chooses to repay the loan, the interest could be tax deductible.
More powering power. A credit line grows over time at the interest rate on the loan. This means that your borrowing power actually grows over time.
Non-recource. HECMs are non-recourse loans. Though the balance of a reverse mortgage can rise above the value of the home, you can never owe more than your home is worth.
Additionally, a credit line from a HECM reverse
mortgage cannot be canceled, which can happen with a home equity
line of credit and did happen during the last financial crisis.
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