What are the Pros and Cons of a Reverse Mortgage?
By: Review Counsel Staff
October 21, 2024 • 6 minute read
A revere mortgage is a great financial tool that may be able to play a role in your retirement portfolio, but as with any financial product, you always want to weigh the pros and cons so you can make an informed decision.
But before highlighting the pros and cons of a reverse mortgage, it’s important to understand what it is and how it works.
What is a Reverse Mortgage and How Does it Work?
While there are three different types of reverse mortgages, the most common type of reverse mortgage is the home equity conversion mortgage (HECM), and the one we will address here. The other types are single-purpose reverse mortgages and proprietary reverse mortgages.
A HECM reverse mortgage provides a way for older homeowners to convert their home’s equity into cash while eliminating monthly mortgage payments.
In order to be eligible for a reverse mortgage loan, you must meet the following qualifications:
- At least one homeowner must be 62 years old or older.
- The home must be the primary residence of the homeowners. (Vacation homes, investment properties, and secondary residences do not qualify.)
- The home must be paid off or have significant equity built up (typically a minimum of 50%, but it may vary depending on the lender).
- The property needs to be a single-family home, a two-to-four-unit property in which the homeowners occupy at least one of the units, or a HUD approved condominium, townhome, or manufactured home.
- The home needs to be maintained and in good condition.
- Homeowners must be able to continue to pay the property taxes, homeowners insurance, and continue to maintain the home.
A HECM reverse mortgage loan will pay off the existing mortgage if there is one. For the remaining loan balance, reverse mortgage borrowers will have the option of receiving the funds as a lump sum, monthly payments, a line of credit, or any combination of the three.
A reverse mortgage is not paid back with monthly payments as would be required with a home equity loan, a home equity line of credit (HELOC), or a cash-out refi. A reverse mortgage is repaid when the homeowners sell the home, the home is no longer the primary residence of the homeowners, or the last remaining borrower passes away.
If the homeowner is living in the home when he or she passes away, the heirs will have the option to sell the home and keep any proceeds, buy out the loan, or leave it to the lender to handle.
The good news for borrowers and heirs is that reverse mortgages come with several protections created by the Federal Housing Administration (FHA). One feature of a reverse mortgage is that it is a non-recourse loan, which means that borrowers or heirs will never owe more than the home’s value.
What are the Reverse Mortgage Pros?
A reverse mortgage comes with many advantages for older homeowners, including the following:
- Retire in place. A reverse mortgage makes it easier for retirees to stay in the home and community they know and love.
- Supplement income. Use a reverse mortgage to Supplement Social Security benefits and retirement income.
- No more mortgage payments. A reverse mortgage eliminates monthly mortgage payments. (Homeowners are still required to pay property taxes, homeowner’s insurance, and maintain the home.)
- Taxes. The money received from a reverse mortgage is not considered taxable income, which means that you do not have to pay income taxes on reverse mortgage funds.
- Retirement portfolio. A reverse mortgage can be used to diversify your retirement portfolio by creating an additional source of funds to use.
- Protect your retirement savings. A reverse mortgage gives you a source of funds to draw from when the market is down.
- Federally backed loan. A reverse mortgage comes with several protections that are enforced by the U.S. Department of Housing and Urban Development (HUD) and the FHA.
- Non-recourse loan. One of those protections includes categorizing reverse mortgages as a non-recourse loan. This means that you will never owe more than what your home is worth.
What are the Cons of a Reverse Mortgage?
- Home maintenance. You are still responsible for maintaining the home and keeping it in good condition as part of the loan terms.
- Taxes and insurance. You must continue to pay the property taxes and homeowners insurance for the home.
- Upfront fees and closing costs. A reverse mortgage comes with high closing costs and fees including origination fees, appraisal fees, the first mortgage insurance premium, and other costs. However, some of these costs can be rolled into the total loan amount. In addition, HUD controls the max amount that lenders can charge for origination fees. The current cap is $6,000.
- Mortgage insurance premiums. Borrowers are charged mortgage insurance premiums each year, which is added to the balance of the loan.
Who Benefits Most from a Reverse Mortgage?
A reverse mortgage used to be viewed as a financial product to turn to as a last resort. While some may still turn to a reverse mortgage in a time of need, many retirement experts now say that it is a good idea to consider adding a reverse mortgage to the retirement plans of older homeowners from the get-go.
- Those who want to stay in their homes. A reverse mortgage is ideal for those who plan to stay in their home for retirement or for a significant amount of time because of the costs associated with obtaining a reverse mortgage. Most experts recommend a minimum of five years. While many people do relocate to warmer climates in retirement, one study found that most people stay in the same home where they were living at age 50.
- Those who need to supplement their income. If your retirement savings and Social Security benefits are not enough to cover your monthly bills, a reverse mortgage may be the solution, especially since it will increase cash flow by eliminating your monthly mortgage payments while also increasing your income in the form of monthly payments.
- Those who are retiring during an economic downturn. The worst time to have to start tapping into retirement investments is during an economic downturn. A reverse mortgage can operate as a source of funds to support you while you wait for the market to turn around.
- Those who need additional financial security. If you don’t have enough emergency savings to cover unplanned expenses, homeowners could opt to receive their funds in the form of a line of credit that they could draw from in times of need.
- Those who need major home upgrades. If you want to retire in place but want to update your home, a reverse mortgage could also be used to fund such renovations.
Who Does Not Benefit from a Reverse Mortgage?
While there are many perks to a reverse mortgage, there are homeowners who may not benefit from one.
- Those with low equity. For those who have a low amount of equity in their home, a reverse mortgage may not be a good solution for their situation.
- Those planning to move. As a rule of thumb, a reverse mortgage is not recommended if you plan to sell your home in five years or less.
- Those who want to leave their home to their children. As mentioned before, you can still leave your home to your heirs, but they will need to pay off the reverse mortgage after you pass.
Bottom Line
If you are considering a reverse mortgage, it is a good idea to consult your financial advisor and any family members that may be affected. If you want to learn more, check out our Complete Guide to Reverse Mortgages to get all of your questions answered.
For more information about our Top 5 Reverse Mortgage lenders, click here.
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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.
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