When used correctly, a reverse mortgage, also known as the Home Equity Conversion Mortgage (HECM), can add stability to your retirement years. However, as with any financial product, it is not always the best program for everyone.
We published this pros and cons guide to help you make an informed decision about reverse mortgages and determine if this program suits your long-term retirement goals.
First, the downsides!
#1. Higher Initial Costs
Reverse mortgages, particularly the HUD HECM (Home Equity Conversion Mortgage), often come with higher costs compared to traditional loans. One significant expense is the FHA mortgage insurance. Borrowers face a 2% upfront fee and a recurring 0.50% annual mortgage insurance premium (MIP). This insurance safeguards both borrowers and lenders from default risks, ensuring that neither borrowers nor their heirs will owe more than the home’s value, regardless of loan balance fluctuations or potential decreases in property values.
While these costs are not paid out-of-pocket, they can be a considerable burden, particularly for homeowners who are sensitive to closing costs. Although lender credits can sometimes offset these expenses, their availability has diminished significantly since the interest rate hikes and inflation of 2022-2023. However, it’s worth noting that the landscape might change, and such credits could become available again. Therefore, shopping around and staying informed about any lender credits that could reduce your costs is advisable.
Considering a proprietary or jumbo reverse mortgage might be wise for homeowners with high-value properties, especially those exceeding the 2024 lending limit of $1,149,825. These properties do not gain additional benefits from values beyond the HUD limit. Jumbo reverse mortgages, which cater to higher-value homes, do not require government insurance and thus save borrowers from the substantial upfront mortgage insurance costs. However, they often come with higher interest rates, which might be refinanced later. For instance, by opting for a jumbo reverse mortgage, borrowers could save up to $22,996.50 in upfront mortgage insurance costs.
#2. Can Impact Eligibility for Needs-Based Assistance Programs
While the funds from a reverse mortgage are not classified as income, they can impact eligibility for needs-based programs like Medicaid or Supplemental Security Income (SSI). This issue arises when borrowers withdraw funds from their reverse mortgage and let them accumulate in their checking or savings accounts, potentially disqualifying them from these assistance programs.
To avoid jeopardizing their eligibility, borrowers must exercise caution in managing these funds. It’s crucial to withdraw only what is needed and ensure that these funds are fully utilized or withdrawn from their accounts before the month’s end. This is especially important when they are required to provide account statements to maintain their benefits from various needs-based programs.
It is important to note that regular Social Security and Medicare benefits are not impacted by obtaining a reverse mortgage. However, for those dependent on other government assistance programs, strategic financial planning is essential to maintain their benefits while leveraging the advantages of a reverse mortgage.
#3. Risk of Exploitation: Safeguarding Seniors in Reverse Mortgage Transactions
Seniors considering reverse mortgages are particularly vulnerable to exploitation by unscrupulous individuals, including those proposing bad investments, family members with failing businesses, or deceitful caretakers. These bad actors often target trusting older adults, seeking to misuse their financial resources for personal gain.
A significant concern in the reverse mortgage process is not the financial product itself but the potential for financial abuse and mismanagement of the funds received. In many instances where reverse mortgage funds are lost, the root cause is not the reverse mortgage but rather how the money was utilized or invested.
It is essential for seniors to remain vigilant and seek advice from trusted, independent financial advisors when considering a reverse mortgage.
#4. Older Versions Lacked Spousal Protections
In older reverse mortgage arrangements, there was a notable lack of protections for spouses under 62 years of age. However, the U.S. Department of Housing and Urban Development (HUD) made significant changes to its guidelines to address this issue. Post-2015, spouses of reverse mortgage borrowers who are under 62 at the time of loan closure are now safeguarded as “eligible non-borrowing spouses.”
These non-borrowing spouses must maintain the home adequately, pay property taxes and insurance promptly, and use the home as their primary residence. These obligations mirror those agreed upon by the original borrower at the time of the loan.
It’s crucial for borrowers and their spouses to understand that while non-borrowing spouses are protected from immediate loan repayment upon the borrowing spouse’s death, they are not borrowers themselves. Consequently, they cannot access any remaining funds from a line of credit associated with the reverse mortgage.
When unused funds are in the line of credit and the borrowing spouse passes away, the non-borrowing spouse can continue living in the home without immediate repayment obligations. However, they are not entitled to draw from these remaining funds.
This protection, while significant, has its limitations. For instance, the loan may be called due if the borrowing spouse leaves the home for reasons other than death. This aspect is an important consideration for couples contemplating a reverse mortgage, especially when one spouse is below the age of 62.
Now for the Pros!
#1. Eliminating Monthly Mortgage Payments
One of the most appealing benefits of a reverse mortgage is eliminating monthly mortgage payments for eligible borrowers. This feature allows individuals to live in their homes for the rest of their lives without the burden of these regular payments. Compared to traditional forward loans, reverse mortgages require less income to qualify, making them a more accessible option for many homeowners.
However, it’s important to remember that while monthly mortgage payments are eliminated, borrowers still have financial responsibilities to fulfill. These include maintaining the property and paying ongoing property charges such as taxes and insurance in a timely manner. Borrowers and lenders are vested in covering these costs to prevent any property risk. This aspect of a reverse mortgage underscores the balance between the benefit of no monthly mortgage payments and the ongoing responsibilities of homeownership.
#2. Unrestricted Use of Tax-Free Funds
A significant advantage of reverse mortgages is the unrestricted use of funds. Borrowers have the freedom to choose how they receive their funds, with options including a single lump sum payment, a flexible line of credit, monthly payments for a set term or for life, or a combination of these methods.
An overlooked benefit of reverse mortgage proceeds is that they are considered tax-free. This aspect greatly enhances their appeal, providing borrowers with a financially efficient means to access their home equity without the typical tax implications associated with income. The tax-free nature of these funds, combined with the flexibility in their usage, makes reverse mortgages a powerful tool for financial planning and meeting diverse personal needs.
Tip! As always, it’s advisable to consult with a tax professional to understand the specific implications for your financial situation. To better understand how a reverse mortgage can benefit you, try our reverse mortgage calculator to receive instant quotes and explore various Home Equity Conversion Mortgage (HECM) loan options.
#3. Lifetime Security: The Security of a Reverse Mortgage Line of Credit
The reverse mortgage line of credit offers a unique benefit of lifetime security, a feature particularly valuable in uncertain financial times. Under this loan agreement, as long as you have remaining funds in your line of credit and adhere to your loan obligations, HUD guarantees these funds will always be available. This assurance is a significant advantage over traditional Home Equity Lines of Credit (HELOCs), which banks can freeze or eliminate without prior notice. Additionally, HELOCs typically have a “draw period,” after which the repayment phase begins, potentially leading to significantly higher payments at a time when your income might be lower.
You have the comfort of knowing that no matter how long you reside in your home, how many withdrawals you make, or what happens to real estate values, you will not be forced to sell your home to repay the loan due to an outstanding balance.
#4. Using a Reverse Mortgage to Buy a New Home
A reverse mortgage offers a versatile solution for refinancing an existing mortgage and purchasing a new home.
This can be a game-changer for those who:
- Are looking to buy a home.
- Need a home that better suits their current needs.
- Aim to reduce their living expenses.
Historically, seniors looking to purchase homes often faced the challenge of paying in cash due to limited income options. This requirement made it difficult for many to consider various housing choices.
Now, with the availability of reverse mortgages for home purchases, seniors have a much more flexible option. They can use a reverse mortgage to buy their new home without the need for monthly mortgage payments. This means that seniors who cannot pay all cash or who prefer not to exhaust their savings from selling their previous home can purchase a new home more feasibly.
This financial tool is particularly beneficial for seniors eyeing homes in 55+ communities or other desirable locations. Prices in these areas might have been prohibitive under traditional cash-only or high mortgage payment scenarios. With a reverse mortgage, these homes become much more attainable.
Furthermore, for seniors who need to relocate for better access to services, family, or friends, a move that might have been unfeasible with a traditional loan becomes possible with a reverse mortgage. This option offers improved living situations, aligning with their changing needs and lifestyle preferences.
Evaluating Reverse Mortgages: Advantages and Disadvantages
|Access to Equity
|Allows homeowners to access the equity in their home.
|May decrease the amount of home equity over time.
|No monthly mortgage payments required while living in the home.
|Loan becomes due upon homeowner's death, moving out, or selling the home.
|Can provide a steady source of income during retirement.
|The loan balance, including interest and fees, accumulates over time.
|Fixed or variable rate options are available.
|Interest may compound over the life of the loan, increasing the total debt.
|Borrowers retain home ownership and can live in the home.
|Homeowners must maintain the home, pay property taxes, and insurance.
|Impact on Estate
|Heirs can inherit the home and choose to pay off the reverse mortgage or sell the home.
|Can reduce the amount of inheritance due to the loan being repaid from estate assets.
|Provides financial flexibility in retirement with various disbursement options.
|May affect needs-based eligibility for certain government benefits such as SSI or Medicaid.
Reverse Mortgage Suitability FAQs
What are the benefits of a reverse mortgage?
What are the drawbacks of a reverse mortgage?
When is a home equity loan better than a reverse mortgage?
Does the bank own the house if I get a reverse mortgage?
Do you need a good credit score to get a reverse mortgage?
Deciding on a Reverse Mortgage: Assessing If It’s the Right Choice for You
It’s crucial when planning to think long-term. Retirement is tricky, and people are living longer. If you choose a reverse mortgage now and later decide to move, you might have less available equity for your next purchase.
Suppose your current home is fully accessible, and you can stay for the foreseeable future. In that case, the reverse mortgage can help fund a more secure retirement.
We have seen reverse mortgages do great things for people who wanted and needed them. However, with your trusted financial advisor and family, only you can decide if this is the right loan for you!