A reverse mortgage is a complicated financial tool that can affect the rest of your life. By taking out a reverse mortgage, you are promising to repay money to the lender when you die, sell or move out of your home.
Due to their complex nature and far-reaching consequences, reverse mortgages are not for everyone. If a reverse mortgage is right for you, it will dramatically increase the stability of your retirement years by giving you access to the substantial sum of money which you have invested in your family home.
Fortunately, before you are legally allowed to take out a reverse mortgage, you first need to undergo reverse mortgage counseling. with an agency or counselor certified by the Department of Housing and Urban Development (HUD). Reverse mortgage counseling will educate you on the basics of a reverse mortgage and give you an unbiased opinion if a reverse mortgage is your best option.
Reverse mortgage counselors do not give out their services for free. Most charge a minimal cost of up to a few hundred dollars (generally $125 to $200, depending on the agency). The counselor is designed to be a neutral third-party who explains the loan program, and they cannot make a recommendation to obtain or not obtain a reverse mortgage. The counselor can only provide information. However, if you just want a rough idea of how good a reverse mortgage will fit in your current situation, then read on to learn more about the pros and cons of reverse mortgages.
What are the pros of a reverse mortgage?
No need to make monthly payments. Perhaps the best thing about a reverse mortgage is that you do not need to make monthly payments. Instead, the loan only becomes due when you die, sell or move out of your house, or fail to comply with its ongoing requirements, such as paying the property taxes and insurance premiums, and keeping the house in good condition.
Lesser income and credit qualifications. Since you do not need to make monthly payments, it naturally follows that the income and credit qualifications for reverse mortgages are less strict than those of conventional mortgages. In fact, on a HECM loan, there is no minimum credit score requirement. For income, you must simply have more income than your expenses and have about $600 of leftover income (exact amount varies by region) at the end of the month after paying credit cards, property tax, and property maintenance charges.
Age in place. As already mentioned, as long as you do not sell or move out of your house, or fail to comply with the ongoing requirements of the reverse mortgage, you can rest easy knowing that you can age peacefully near family, friends, and familiar surroundings. Studies show that around 80 percent of adults nearing retirement want to stay in their current homes as they age. If you are part of this 80 percent, then getting a reverse mortgage can help you achieve this goal.
Boost monthly income or cash reserves. If you are like most senior citizens, you will likely suffer a sudden and substantial drop in your monthly income when you retire. Obviously, this will require you to make corresponding changes in your lifestyle and standard of living. Refusing to make these changes will eventually lead to financial instability since you will regularly be spending more money than you are making. Fortunately, reverse mortgages provide an easy solution to this common problem. The proceeds of a reverse mortgage can be claimed through a lump sum, monthly payments, line of credit, or a combination of these methods. In other words, getting a reverse mortgage can help you increase and stabilize your post-retirement finances.
Non-taxable proceeds. According the Internal Revenue Service (IRS), the proceeds of a reverse mortgage loan are not considered income and are, therefore, not subject to income tax. In other words, you can potentially enjoy all the benefits of an increased “monthly income” (if you choose to receive your loan proceeds on a monthly basis), without having to worry about taxes. As you probably know, however, taxes can be pretty complicated, so if you are unsure about the tax implications of your reverse mortgage, please consult either your accountant, lawyer, tax professional or reverse mortgage counselor.
Absolutely no liability for heirs. As already mentioned, the reverse mortgage loan becomes due when you die.
At this point, your heirs have two options. They can either:
- pay the balance of the loan and keep your house; or
- allow the lender to foreclose the mortgage and sell the house.
If they choose the second option, several things can happen:
- the proceeds of the sale will equal the balance of the loan, in which case the lender keeps the entire amount as payment for your loan;
- the proceeds exceed the balance, in which case your heirs will be allowed to keep the excess; or
- the proceeds are less than the balance, in which case the lender can only recover the deficiency from the loan insurance.
In all these scenarios, your heirs stay absolutely free from any liability beyond the value of your house.
Does not affect Social Security Retirement, Social Security Disability, or Pension Income. Your Social Security retirement or Social Security disability income will not be affected by obtaining a reverse mortgage. Additionally, you will continue to receive any private pensions you receive as well. This is a general rule, but for more details, check with the program directly.
Freedom to spend. Generally speaking, you can use the proceeds of your reverse mortgage loan for practically anything. Whether you want to take a lump-sum payment and spend the money on a more profitable investment or receive a steady stream of monthly payments to supplement your decreased income, you are free to choose what to spend your money on. Remember, it is “your” home that is being mortgaged, it is “your” money being spent, and it is “your” choice on what to spend it on. Just make sure that you keep enough in the bank for your daily needs and to comply with the ongoing requirements of the reverse mortgage. The only exception to this rule is when you take out a “single-purpose reverse mortgage,” which is a type of reverse mortgage loan where the proceeds can only be spent on a predetermined purpose. While they are relatively rare, some entities (mostly state governments) still offer single-purpose reverse mortgages.
What are the cons of a reverse mortgage?
Higher closing costs. When compared to conventional mortgages, reverse mortgages tend to have higher closing costs. These closings costs typically include origination fees (the fee charged by the lender for processing the loan), appraisal fees (the fee charged by a professional appraiser for determining the market value of your home), recording fees (the fee charged to record the mortgage in the county recorder’s office), notarial fees (the fee charged by the notary public for his services), and mortgage insurance premiums (the fee paid to the insurer which will be the Federal Housing Authority (FHA), if you are taking out the most common type of reverse mortgage, the Home Equity Conversion Mortgage (HECM)). These closing costs do not need to be paid out-of-pocket and can simply be charged against your loan proceeds. However, the fact remains that you will still need to pay for them and that they can be rather substantial.
Some needs based programs may be affected. Some needs-based programs offered by the US government, such as Medicaid and Supplemental Security Income (SSI), have very stringent requirements. Any violation, even if unintended, can result in disqualification. For example, the Medicaid and SSI programs impose strict asset restrictions on beneficiaries, which you may potentially violate when enjoying the benefits of your reverse mortgage. All of this is pretty complicated, so it would probably be best if you consult a lawyer, legal clinic, or a program expert for further advice.
May have a maximum loan limit. The amount you receive from your reverse mortgage loan is principally determined by the market value of your home. The more expensive the home, the higher the maximum loan limit. However, if you are planning to take out an HECM, do note that the government imposes a maximum loan limit of $765,650. In other words, even if you have an extremely expensive home, there will always be a limit on the amount of equity you can convert into cash in HECMs. However, if you take out a different type of reverse mortgage, such as a proprietary reverse mortgage (also referred to as a jumbo reverse mortgage), you can effectively bypass this government-imposed loan limit. In exchange, proprietary reverse mortgages typically have higher interest rates and are not insured by the government.
Leaving less inheritance. If you are like most Americans, your family home is probably your most valuable asset. However, since reverse mortgages draw on your equity, basically allowing you to convert the value of your home into cash, you will eventually be leaving your heirs with less inheritance. Moreover, if you want your heirs to keep your family home after you are gone, they will have no other option but to repay the balance of the loan after your death. They can refinance the loan or simply walk away from the house.
Possible foreclosure on your home. Like conventional mortgages, reverse mortgage lenders can also foreclose on mortgaged properties. Now, if you may have initially thought that foreclosure is impossible in reverse mortgages since you do not have to make monthly payments. Reverse mortgages can still be foreclosed during your lifetime if you fail to comply with its ongoing requirements, i.e. when you fail to make timely payments for property taxes and insurance premiums. If your lender finds that the terms of the loan are not being met, you will receive a notice of default which allows you to correct the existing issues before the actual foreclosure. The corrective measures you will need to take will depend on the issues raised by your lender. If you receive a notice of default, you should contact your reverse mortgage servicer as soon as possible.
Should you get a reverse mortgage?
Now that you know the pros and cons of a reverse mortgage, you are probably asking yourself if you should get one. While we may not be able to give you a definitive answer, we can at least help you decide for yourself.
A lot of Americans have very little money set aside for retirement. If you only have a few thousand dollars saved, then you might be able to live on that for the next few years, but it will definitely not be enough for the next 10 to 20 years. Getting a reverse mortgage can definitely ease your financial burdens, giving you a steady and reliable stream of cash to supplement your savings or monthly income. On the other hand, if you think you can live on your current monthly income if you can just minimize your expenses and upkeep, then maybe your best option would be to just sell your family home and move into a smaller one. This option is usually referred to as downsizing and could make a lot of financial sense if done correctly. Finally, if you are just experiencing a temporary spike in expenses, then a reverse mortgage might not be the best option. Instead, it may be better to take out a simple and straightforward loan.
Always bear in mind, however, that reverse mortgages are complicated financial tools with very significant long-term consequences that you will have to live with during your retirement years. With that said, you should always consult your reverse mortgage counselor or attorney whenever you need a more detailed opinion.