Pros and Cons of Reverse Mortgages
Should You Get a Reverse Mortgage?
According to the U.S. Department of Housing and Urban Development (HUD), approximately 64,000 reverse mortgages were created in the 2022 fiscal year, with 2023 on track to be even lower. This is significantly less than their peak during the housing bubble, with over 100,000 reverse mortgages taken out each year between 2007 and 2009. Although they’re declining in popularity, reverse mortgages can still be a great source of income for people over the age of 62 who do not have many other income streams and cannot take out a personal loan.
What is a reverse mortgage?
A reverse mortgage is a loan that taps into your home equity, similar to a home equity loan, except you do not have to make payments on it. There are also no income or credit score requirements for a reverse mortgage. The interest gets rolled into the loan balance, which adds up against your equity. You do not have to pay back the loan until you pass away, sell the house, or stop living in it for more than a year. The proceeds from the home sale will first go towards paying off the loan, and the rest is yours (or your heirs).
Requirements to get a reverse mortgage
• Must be 62 or older
• Cannot have any federal debt, including federal student loans
• The house must be your primary residence
• You must have a significant stake in the equity of the home (usually at least 50%)
Before going further in the process, it is important to weigh the pros and cons of taking out a reverse mortgage.
Pros:
• You get to stay in your home – One of the alternatives to a reverse mortgage is selling your home and renting or downsizing to make some money off the sale. Taking out a reverse mortgage means you get to keep your home and avoid the hassle of selling and moving.
• No monthly payments – Unlike most other loans, reverse mortgages do not require any monthly payments. The interest, fees, mortgage insurance, etc. reduce the equity in your home.
• No maximum loan balance – If the loan balance exceeds the value of your home, you are only responsible for paying back 95% of the home’s value when you sell. Mortgage insurance will cover the rest of the cost.
• Payments aren’t taxed – Since the payments are loan proceeds that will be paid back by your home’s equity, payments are not taxable. This also means that payments will not affect your Social Security or Medicare.
Cons:
There are also some downsides to consider before deciding on a reverse mortgage.
• High startup costs ¬– Taking out a reverse mortgage can come with high closing costs. The origination fee alone can be up to $6,000. These costs can be rolled into the loan, but that means interest will accrue on the closing costs.
• Principal residence requirement – One of the requirements for a reverse mortgage is the property must be your principal residence. This means if you have to go to a hospital, nursing home, or hospice facility for more than 12 consecutive months, you may lose your home.
• Variable interest rates – Some reverse mortgages can be set up as a fixed rate, but most of them are variable. This means you may pay more or less interest on the loan, depending on the current market environment.
• Paying off the loan – Unless you or your heirs have enough money to pay off the loan, the house will have to be sold to pay it off. If you hope to pass your house down to the next generation, a reverse mortgage may not be the best option.
Alternatives
Reverse mortgages can be a great resource for some, but they are not a great fit for everyone, so here are some alternative options for you to consider.
• Selling your home and renting ¬– Selling your home can bring in a large sum of money that can be invested. Although you will still have to pay rent, you will not have to pay property taxes, homeowner’s insurance, or maintenance costs. However, your rent price may increase with inflation.
• Downsizing – If you have a larger house than you need, downsizing can be an attractive alternative because you remain a homeowner, while also generating a profit from the sale of your house.
• Home Equity Line of Credit (HELOC) – A HELOC allows you to draw money any time you want and only charges interest on what you have withdrawn. This is a good alternative if you do not need a steady stream of income and want some flexibility in your spending. Because you do have to make payments on a HELOC, there may be income or credit score requirements.
The pros and cons listed here are a condensed version of the full list. Before taking out a reverse mortgage, all potential borrowers are required to go to a HUD-approved counseling session to discuss the implications of the loan. These counselors can give you all of the necessary information and answer any questions you may have before going through with it. You should also speak with a financial professional to discuss if a reverse mortgage is right for you.
Authors: Dillon Key and Jeff Donham
Dillon Key– Richmond, Associate Wealth Advisor Intern 2023