Is a Reverse Mortgage a Good Idea?
By: Courtney Jorstad
February 5, 2023 • 8 minute read
There’s a lot of conflicting information out there about reverse mortgages. You don’t have to look very far before you run into warnings about “reverse mortgage scams” that may lead you to believe that a reverse mortgage is a financial product you should avoid.
The Home Equity Conversion Mortgage (HECM), commonly known as a reverse mortgage, is a federally backed loan, and it is legitimate financial product designed to allow older homeowners a unique way to access the equity in their homes, but unfortunately, that doesn’t stop scammers out there from trying to take advantage of vulnerable Americans.
The truth is that a reverse mortgage isn’t right for everyone, but for those who are facing specific challenges or who have certain needs, it may be the solution they’ve been looking for.
In this article we will discuss when a reverse mortgage is a good idea, and when it isn’t.
Let’s dive in.
What is a Reverse Mortgage?
Before discussing whether or not a reverse mortgage is a good idea, we first need to know what it is.
A HECM reverse mortgage loan is only available to homeowners who are 62 years of age or older and have significant equity in their homes. The home must also be the primary residence of the homeowners. Reverse mortgages cannot be obtained for a vacation home or investment property.
It provides a way for homeowners to tap into their equity without having to take on additional monthly mortgage payments. When a homeowner takes out a reverse mortgage, it pays off the current mortgage, if there is one, and eliminates the monthly payments that go with it.
The home still belongs to the borrowers, not the bank, which means that homeowners are still required to pay property taxes, homeowner’s insurance, and maintain the home.
For any remaining equity, borrowers have the option of receiving their funds as a lump sum, monthly payments, a line of credit, or a combination of the three.
There are no limitations on how the money can or can’t be used. The money that homeowners receive can be used however they would like. Some common uses include supplementing monthly income, funding major home projects such as home upgrades and renovations, paying off credit card debt and personal loans, and as a backup source of funds to cover unplanned expenses.
A reverse mortgage may also be used to purchase a new home, this is known as a reverse mortgage for purchase or HECM for purchase.
A reverse mortgage is paid back when the homeowner decides to sell, the home is no longer the primary residence of the homeowner, or when the homeowner passes away.
When is a Reverse Mortgage a Good Idea
Reverse mortgages used to be viewed as a last resort to pursue when retired homeowners needed additional cash, but this is no longer the case, The New York Times said in a report in 2022.
A reverse mortgage is now seen as a potential solution for a variety of needs and situations, including the following:
- When you plan to retire in place. A reverse mortgage makes it easier for those heading into retirement to be able to retire in place. It can be used to help supplement income, fund home renovations, or cover other costs. While retirement communities abound throughout the country in states such as Florida, Arizona, and elsewhere, a study from the Center for Retirement Research found that most retired Americans stay in the same homes where they lived in their early 50s.
- When you need to supplement your income. If homeowners find that Social Security payments and other sources of income aren’t cutting it, they may look for other ways to supplement their income. “Home equity is the largest store of savings for most households entering retirement,” the Center for Retirement Research said in a report.
- When you need added protection. A study conducted every three years by the Federal Reserve found that most Americans are not saving enough for retirement. The study found that Americans from age 55 to 64 has a median retirement savings of $134,000. While this is a decent amount of money, it’s not enough to cover all the costs expected in retirement. For those who find themselves in this situation, a reverse mortgage may be the solution they need to offset costs.
- Preserve savings and cash reserves. Some Americans are starting to turn to reverse mortgages as a way to preserve their savings and cash reserves. Virginia woman Marjorie Fox told The New York Times that she decided to take out a reverse mortgage for exactly this reason — she wanted to prepare for the unexpected, so she decided to receive her reverse mortgage funds as a line of credit.
- Protect investment portfolios. The stock market goes up and down, which affects 401ks and other investments. If the stock market takes a downturn when it’s time to retire, a homeowner could use a reverse mortgage to supplement their income while they wait for the market to recover before they pull out their investments.
- Delay claiming Social Security benefits. Social Security benefits go up a small percentage for each month retirees delay claiming their benefits. A reverse mortgage could be used to supplement income until Social Security beneficiaries are ready to claim their benefits. Homeowners can take out a reverse mortgage at age 62. However, they can delay taking Social Security benefits until age 70.
- Pay large medical bills and credit card debt. For Americans heading into retirement with a large amount of credit card debt or medical bills, a reverse mortgage could also be used to pay off this debt.
There are other ways to access your equity without taking out a reverse mortgage such as a Home Equity Loan, a Home Equity Line of Credit (HELOC), cash-out refinancing, or selling the home.
When a Reverse Mortgage is Not a Good Idea
While there are times in which a reverse mortgage is a good idea, this is not the case for everyone.
Here are some situations in which a reverse mortgage may not be the right choice:
- If you plan to move. While a reverse mortgage can be used to purchase a new home, a reverse mortgage may not be the best way to go if you plan to move.
- If you want to leave your home to your children. Because a reverse mortgage uses up a large portion of your equity, it may make it more difficult for your children or heirs to keep your home after you pass away. After you pass, your heirs will be given the option to sell the home and keep the proceeds or keep the home. But if they keep the home, they will need to pay the balance of the loan or 95% of the appraised value.
- If you can’t afford to maintain the home and other costs. As explained before, in order to have a reverse mortgage, you will still be required to continue to pay the property taxes, the homeowner’s insurance, any dues such as HOA fees, and pay to maintain the home. While a reverse mortgage can offset these costs, if you think you will struggle to cover these costs, then a reverse mortgage may not be the way to go. Most reverse mortgage lenders will assess your financial health to make sure you are able to meet all reverse mortgage requirements before moving forward with the application.
Reverse Mortgage Protections
Because there are scammers out there, the federal government has established several added protections to give homeowners additional peace of mind. Some of those protections include the following:
- Third-party counseling. Before homeowners can submit an application for a reverse mortgage, they must first complete a counseling session with a counselor who is approved by the U.S. Department of Housing and Urban Development (HUD). The counselor will ensure that the potential borrowers understand what a reverse mortgage is, how it works, as well as potential alternatives. This is an added layer of protection to make sure that homeowners understand the product and do not fall prey to would be scammers.
- Non-recourse loan. A HECM reverse mortgage is a non-recourse loan. This means that you will never owe more than what the home is worth. This protects homeowners in the event that the loan is larger than the market value of the home.
- Right to cancel. Homeowners have the right to cancel a reverse mortgage at any time during the application process including three business days after signing closing documents.
- First year principal limit. When homeowners take out a reverse mortgage as a lump sum, they may only take out 60% of the loan amount during the first year. This is to ensure that your money lasts longer.
- Non-borrowing spouses. The FHA also has protections for non-borrowing spouses in the event that the borrower leaves the home for more than 12 months. This may happen if he or she goes to live in a long-term healthcare facility, or the borrower passes away while the non-borrowing spouse is still living in the home.
The Bottom Line
Taking out a reverse mortgage loan is a major decision. Since it’s not available to homeowners until they are 62 years old, most of us don’t have a lot of experience with how the process works or how to get started.
That’s why we aim to provide in-depth information about reverse mortgages and reviews about the top reverse mortgage lenders.
If you want to learn more check out our free reverse mortgage guide here. Also, check out this list of our top recommendations for reverse mortgage companies.
This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.