Is getting a reverse mortgage a good idea?
There is quite a lot of negative talk surrounding reverse mortgages. For one, a lot of people believe that taking out a reverse mortgage means selling off your home to the lender. Others hesitate to apply for a reverse mortgage because they think there is a high risk of foreclosure. Some are afraid that they will have to pay taxes on their loan proceeds. And the list goes on.
While a lot of these “fears” do not stem from nothing, most of them are simply not true. Unfortunately, these myths hold people back from taking full advantage of the benefits that a reverse mortgage can provide. A reverse mortgage, when done right, can be the ultimate tool for financial freedom in retirement. Hence, we want our readers to know only the truth about reverse mortgages–and why a reverse mortgage is not a bad idea.
What is a Reverse Mortgage?
A reverse mortgage is a financial product that allows you to access your home equity. But unlike other types of home equity loans, a reverse mortgage does not require repayment. The balance only becomes due when you pass away, sell the home, move away permanently, or fail to keep up with ongoing loan obligations. Until then, you retain full ownership of the home and can live in it for the rest of your life.
The most common type of reverse mortgage is the Home Equity Conversion Mortgage or HECM. An HECM is the only federally-backed reverse mortgage loan, insured by the Federal Housing Administration (FHA). FHA insurance protects borrowers from lender failure and, in turn, protects lenders if borrowers default on their loans.
Who Can Apply For a Reverse Mortgage?
A reverse mortgage is only available to homeowners 62 years old and above. You must also own the property outright or have enough home equity, depending on the type of loan you are applying for. For example, an HECM requires borrowers to have at least 50% equity on the mortgaged property.
In addition to these requirements, the borrower must also:
- Be using the property as their primary residence
- Have no delinquent federal loans or property taxes
- Pass a financial assessment test
- Undergo reverse mortgage counseling from a counselor approved by the Department of Housing and Urban Development (HUD); a requirement for HECM
What Are The Pros and Cons?
Just like any other type of loan, a reverse mortgage has its own unique pros and cons. Let’s talk about both sides of the coin in greater detail:
1. Increased cash flow
If you are still paying off the mortgage at the time of application, securing a reverse mortgage will make all future repayments optional, which can free up a good chunk of your monthly budget. More importantly, instead of you paying the mortgage, the lender pays you–thus providing a significant amount of cash that can help supplement your retirement income.
In other words, you have less liability and more purchasing power. You can live the lifestyle you want, and you won’t have to think about mortgage payments again.
2. Tax-free income
The Internal Revenue Service (IRS) does not consider reverse mortgage proceeds as income. Thus, you can receive your reverse mortgage loan entirely tax-free.
3. Full ownership
When you take out a reverse mortgage, you retain full ownership of your property until you decide to sell it. Getting a reverse mortgage does not mean that you are selling your home to the lender.
4. No repayment penalty
Repayment is optional with a reverse mortgage loan. But if you wish to pay up your loan, you are free to do so anytime without repayment penalties or fees.
Reverse mortgages include a non-recourse clause which means you will never owe more than your home’s value. If, for example, home prices fall and your loan balance ends up being higher than the market value of your home, you nor your heirs do not have to pay the difference.
1. Potential effect on retirement benefits
A reverse mortgage will not affect Medicare, social security, and other public benefits unless you were receiving assistance on the basis of certain needs. Other sources of additional income apart from a reverse mortgage can also affect your eligibility.
2. Less inheritance for your heirs
Getting a reverse mortgage may impact your heirs’ inheritance. Paying off the loan balance is usually done by selling the home or turning it over to the lender when you pass away. However, your heirs have the option of refinancing the loan or buying it with cash if they wish to keep the home in the family. Nevertheless, this may mean having little equity left for your surviving kin.
3. Possibility of outliving the loan
Unless you are careful with your money, there will always be a possibility of outliving your loan proceeds. Receiving your funds in a lump sum carries the most risk of this happening. For example, if you receive the entire loan outright, there is a higher chance of you spending it all before you pass away.
To avoid this, we recommend receiving your funds through fixed monthly payments or a line of credit. In this way, you have more control over how much you spend, and there is less temptation of spending all the money at once.
When Is a Reverse Mortgage a Good Idea?
With enough planning and financial responsibility, a reverse mortgage may just be your saving grace. Think about it: you receive a significant amount of income to help you with your monthly expenses and you no longer have to pay the mortgage (if you are still paying it off). The financial freedom that a reverse mortgage provides can help you live the life that you want during your retirement. Plus, you can stay in your home until the balance becomes due, allowing you to age in place peacefully.
Getting a reverse mortgage is a good idea if you plan to stay in your home for the rest of your life. More importantly, you should be financially responsible enough to budget the loan proceeds accordingly so that you do not outlive your loan. If you tick all of these boxes, then getting a reverse mortgage may be the right choice for you.
When Is a Reverse Mortgage a Bad Idea?
Just like any other loan, a reverse mortgage is not suitable for everybody. We do not recommend getting a reverse mortgage if you plan to relocate in the future. This is because the closing costs of a reverse mortgage can be high, similar to traditional mortgages. If you move away after getting a reverse mortgage, you will end up losing money in the long run.
We also do not recommend getting a reverse mortgage if you do not have a plan on how to avoid outliving your loan. Before you take out this type of loan, you must have a clear strategy on how to budget your money and make it last for the rest of your life. Otherwise, you may risk running out of money before you pass away, which can open up a whole new world of problems for you and your family.
Learn More About Reverse Mortgages Today
Bottom line: a reverse mortgage is not a good idea for everybody. But the same also applies to other types of loans. If you plan to move away someday, don’t have a good financial plan for the future, or have no capacity to comply with ongoing loan obligations, then now is not a good time to get a reverse mortgage.
On the flip side, if you meet all of the criteria, are financially responsible, and plan to stay in your home for the rest of your life, a reverse mortgage is likely going to be a smart move.
Everyone is always going to carry a certain level of risk, but when you do it right, you can take full advantage of all the benefits of a reverse mortgage. If you want to learn more about reverse mortgages, don’t hesitate to contact us today. Our reverse mortgage specialists are always ready to assist and educate!