Beach vacations, beers on the golf course, picking up that dusty guitar you put down decades ago. Everyone dreams about living the relaxing retirement lifestyle, but not everyone plans out how to pay for it.
Homeowners without a solid retirement plan may be relying on their home’s value to fund their post-career plans—the question is, how do you get that equity out?
If you listen to celebrity endorsers like Alex Trebek, Robert Wagner, Henry Winkler and Tom Selleck, it sounds like getting a reverse mortgage—a special loan for seniors over 62 that turns equity into cash—is your best option.
Before weighing the pros and cons, you first need a clear understanding of how a reverse mortgage works or you could wind up in serious debt. That’s where we come in: we did the research and talked to experts to put together this comprehensive pros and cons list.
That way, you can make an educated decision about whether a reverse mortgage is right for you.
Let’s Start with the Basics: What is a Reverse Mortgage?
According to the U.S. Department of Housing and Urban Development (HUD), a reverse mortgage is a loan that converts home equity into cash for retiring homeowners while allowing them to continue living in their homes.
The concept may be simple, but the process is deceptively complex—and it’s an option with a number of negatives to consider.
It can also be tricky to get one.
Retiring from full-time work doesn’t automatically make you eligible for a reverse mortgage. In order to qualify:
- you must be age 62 or older
- the property must be your principal residence
- you must own your home outright (or have a low-balance existing mortgage that can be paid off with the reverse mortgage proceeds)
Other qualification requirements vary depending on the type of reverse mortgage you choose.
3 Main Types of Reverse Mortgages
There are essentially three types of reverse mortgages: single-purpose, proprietary, and Home Equity Conversion Mortgages (HECM).
A single-purpose reverse mortgage allows qualifying retirees to pull funds out for a specific, lender-approved reason, such as replacing a roof or paying a tax debt. This type of loan isn’t available in every state, and in some areas it’s only an option for low-income applicants.
On the flip side, the proprietary reverse mortgage typically appeals to more affluent retirees. That’s because there is no cap on the amount of equity that can be borrowed against the value of the home.
Both single-purpose and proprietary reverse mortgages are private loans, so they aren’t subject to as many of the rigid regulations of a government-backed loan. They are also not insured by the federal government.
That’s why most retirees opt for a lower risk, federally insured reverse mortgage. Known as a Home Equity Conversion Mortgage (HECM), this loan is only available through an FHA-approved lender and is the only reverse mortgage insured by the U.S. Federal Government.
As a protective measure, HUD requires all applicants to work with an HECM counselor who will use HUD-approved Reverse Mortgage Analyst software to help determine if a reverse mortgage is the right financial option.
In another step to protect retirees, the federal government also regulates how much equity can be pulled out with an HECM loan. The HECM lending limit is $679,650 (as of January 1, 2018), regardless of your home’s current market value.
One variation of the standard HECM can even help you finance a new house.
The HECM for Purchase is a relatively new, little-known loan that helps retirees sell their existing home and buy a smaller (or more age-accessible) home without paying closing costs twice. With this loan type you will need to make a sizable down payment—roughly half of the purchase price of the new home.
No matter which type of reverse mortgage you settle on, all come with the same pros and cons to consider.
Pro #1: A Reverse Mortgage Lets You Spend Equity Without Selling
If you’re in a position to qualify for an HECM, you’ve likely spent years paying off your traditional home loan until it’s become a tidy nest egg. With a reverse mortgage, you can pull out a portion of that equity without selling the home as a means to access its cash value. You continue living in the property and the title remains in your (the homeowner’s) name.
How does this work?
A reverse mortgage functions in a similar fashion to a Home Equity Line of Credit, where a bank lends you cash using your home’s equity as collateral. Those funds are then available to you as a lump sum, a line of credit, or in monthly installments paid to you.
Nile Lundgren, a top New York agent and Bloomberg TV commentator, who was named Executive of the Month by the New York Real Estate Journal, understands why this type of loan is attractive to some retirees:
“For Americans who don’t have retirement savings, the home they own free and clear may be the most effective way to fund a retirement. What makes a reverse mortgage so appealing is that retired homeowners can turn the value of the home into cash without moving or having to make monthly payments.”
Pro #2: No Monthly Payment to Make with Reverse Mortgages
That’s right. Unlike a traditional home equity loan, retirees can access their home’s equity without making monthly mortgage payments to the lender.
Instead, the bank pays you, providing retirees with a reliable source of income. And this income source is typically tax-free because it’s considered a loan advancement, not (taxable) earned income.
You won’t need to pay back the reverse mortgage monthly, but that doesn’t mean you’re completely free from house-related bills. You are still financially responsible for things like property taxes, utilities, and home insurance payments.
Pro #3: Funds Give You Financial Freedom to Delay Collecting Social Security
Taking out a reverse mortgage is also one way to delay claiming Social Security benefits. Social Security benefits increase annually between the ages of 62 and 70, which is why some retirees decide to wait to claim them.
If you retire in your early 60s but want to wait until you’re eligible to receive the maximum Social Security benefits, a reverse mortgage can serve as a source of income to cover your expenses in the meantime.
These are just a few of the potential benefits to taking out a reverse mortgage, but there are drawbacks, too.
Con #1: You’re Spending Down Your ‘In Case of Emergency’ Equity
A reverse mortgage is a great way for you as a homeowner to find greater financial freedom in retirement—however, when you tap into your home’s equity, you are risking that it will eventually be tapped out.
Although a reverse mortgage doesn’t require a monthly payment, it’s still a loan that must eventually be paid off. Lundgren explains:
“People might think it’s free money, but just be aware that you have to pay it back. It’s critical when you’re doing a reverse mortgage to talk with a reverse mortgage specialist because you’re basically borrowing against the value of your home.”
You must remember that with a reverse mortgage you are borrowing money.
With a traditional mortgage, your loan balance gets paid down over time. With a reverse mortgage, your loan balance goes up.
Because reverse mortgage lenders do charge interest on reverse mortgage loans. And that interest rate can change and increase if a fixed rate isn’t written into the terms of your reverse mortgage.
The more equity you take out and the longer a reverse mortgage stays on a home, the more those interest rates eat up any remaining equity.
If there comes a time when you need to sell your home to cover major expenses like extensive medical bills, you may not have enough equity left to cover the debts.
Con #2: The Whole Loan Comes Due the Moment You Leave the Home
Remember all of those mortgage payments you weren’t making on your reverse mortgage? Well, that loan condition only exists as long as you live in the home as your primary residence.
The minute the home is no longer your primary residence, your reverse mortgage comes due. It comes due immediately, whether you transition into assisted living, permanently move to another residence, or pass away.
Even if your heirs are listed as beneficiaries in your will, the reverse mortgage comes due upon your demise. If your heirs want to keep your home in the family, they’ll need to immediately pay off the reverse mortgage balance. Otherwise the home must be sold to pay off the reverse mortgage.
There is a silver lining, though.
According to the Consumer Financial Protection Bureau, an FHA-insured HECM loan is a non-recourse loan, which offers you a nice safeguard.
If your home sells for less than the equity you took out, the insurance will make up the difference. That means neither you (or your family!) are at risk of having to pay more than what you get from the sale of your home, as long as the home sells for 95% of its appraised value.
So for example, if you took out $200,000 in equity, and your home only sells for $190,000, the insurance would pay that extra $10,000. (That’s why you get insurance.)
It’s true that this insurance protects you from owing more than the home is worth. However, this also means that a reverse mortgage can potentially absorb all of the equity you’ve built up in your home.
Con #3: Using a Reverse Mortgage to Delay Social Security Benefits Can Backfire
While funds from an HECM loan can support you if you want to wait for better Social Security benefits, it might not be worth it.
A recent study conducted by the Consumer Financial Protection Bureau (CFPB) found that you are likely to pay more in fees and interest for the lifetime of the reverse mortgage than you’ll get the in lifetime benefits of delaying your Social Security claim. The difference is about $2,300 by age 69, the research found.
Homeowners who take this route forget a few very important things:
- a reverse mortgage is with you for your lifetime, or until you sell your home and pay it off
- you’re not making monthly mortgage payments on the loan so the debt isn’t getting paid down
- the bank continues to charge monthly interest on the reverse mortgage
As long as the reverse mortgage stays in place, the monthly interest is slowly adding to the debt you owe over time—which means you could potentially owe the entire value of your home to the bank.
The only way to prevent this is to pay off the reverse mortgage.
By design, reverse mortgages are paid off in one payment upon the sale of the house. So, you could plan to sell the home to pay off the reverse mortgage once you’re ready to start collecting Social Security.
However, it may actually be financially smarter to simply sell now and live off of the proceeds until you’re ready to claim your benefits. That way you won’t spend a good chunk of your equity on interest paid to your reverse mortgage lender.
Alternatively, you might decide to make monthly payments on your reverse mortgage even though they aren’t required. Thankfully, most reverse mortgages allow you to pay down the principal of the loan without penalty.
Bottom Line: Pull Out Only As Much Equity As You Need
A reverse mortgage is a good option to allow retirees access to their home equity without selling or taking on a large monthly mortgage payment. But it can also be a costly option with a number of upfront costs, including closing costs, lender fees and mortgage insurance.
Plus, the interest may wind up costing you more equity than you expect. That’s why the CFPB recommends taking out only a little equity at a time. This prevents you from paying larger interest rates on bulk funds that you don’t immediately need.
If you’re unsure about how much to borrow, or if a reverse mortgage is even right for you, ask for help. Along with HUD-approved HECM counselors, the government has other organizations to help retirees with their financial planning.
The Administration for Community Living (ACL) provides contact information for a number of aging and disability networks. And the Elder Care Locator can assist you in finding local financial assistance that’s low or no cost.
Others promise to help process the loan, only to keep the majority of the loan proceeds to cover fraudulent “fees,” leaving you with nothing but the debt. If you feel that you’ve been a victim of this fraud, make sure to file a complaint with the FBI and contact an HECM counseling resource for help.
A reverse mortgage can sound like fast, easy access to your home equity. In reality, the process is tricky. Navigating both state and federal regulations to reach the best reverse mortgage deal for you isn’t easy, but it can be done.
Before committing to a reverse mortgage, consult with a top notch real estate agent on your home’s current value and available retirement housing options. This is the best way to determine if selling is a better financial option for you than a reverse mortgage.