Reverse mortgages have garnered a bad reputation over the years. Some people even go as far as to call them ‘scams’. But why do reverse mortgages have a bad rap? And are any of these negative claims true?
Reverse mortgages can become powerful financial tools with proper utilization. They can save retirees from financial ruin. They can help people build lines of credit over time. They can finance large expenses that a borrower would have no way to pay otherwise. Reverse mortgages can give borrowers the financial power to do a lot of things. However, the bad reputation that reverse mortgages have can hinder them from gaining that kind of capacity.
Why Do Reverse Mortgages Have a Bad Reputation?
When assets become liquid, they tend to deplete rapidly in the wrong hands. This is the main reason why reverse mortgages have developed a bad reputation. A reverse mortgage turns a borrower’s biggest asset–their home–into cash. Without enough self-control, there is a good chance that that money is going to be gone sooner than one thinks.
There are other factors that contribute to this negative impression on reverse mortgages. Some have been regulated by the government, such as the new protections in place for non-borrowing spouses that allow them to remain in the mortgaged home even after the borrowing spouse has died.
Others are linked to the common problems that families face amongst themselves, such as miscommunications about inheritance and irresponsible spending of loan proceeds.
How Does a Reverse Mortgage Work?
A reverse mortgage is a type of loan product that allows you to borrow against the value of your home. In other words, it allows you to access the home equity that you have built up so far. Unlike other home equity loans, a reverse mortgage stops your mortgage payments, and the loan does not become due until you die, move away permanently, sell the home, or fail to keep up with loan requirements.
To qualify for a reverse mortgage, you have to be at least 62 years old, be a principal owner of the house, have 50% or more in home equity, and have the mortgaged property as your primary residence.
When you take out a reverse mortgage, you keep full ownership of the home. You can make repayments on the mortgage if you want (or pay the interest that the loan has accrued), but it is not required. When it comes to the loan proceeds, you can receive your funds through:
- A lump sum
- A line of credit
- Term payments
- Tenure payments
When the balance becomes due, the lender will sell the home to pay off the balance. Alternatively, your heirs can pay off the loan or refinance the mortgage to keep the property.
Why Getting a Reverse Mortgage May Be a Smarter Choice Than You Think
Why is getting a reverse mortgage a smarter choice than you think? The correct answer depends on the person you’re asking. Each borrower has a different set of goals. A reverse mortgage can meet either all or none of them.
For example, if your goal is to remain financially independent but your retirement income is limited, taking out a reverse mortgage may be more sustainable than selling other assets. Or if your goal is to finance travel after you retire, you can use a reverse mortgage line of credit to pay for your trips without having to pay them back (as opposed to using a credit card).
To be able to understand why a reverse mortgage can be a smart choice despite the stigma around it, you have to know the advantages it can provide.
With the right borrower, a reverse mortgage can lead to significant benefits. Most notably:
No more mortgage payments. A reverse mortgage does not require repayment unlike types of home equity loans. If you are a retiree and are still paying off the mortgage, this can free up much-needed cash flow for other important expenses.
Full ownership. When you take out a reverse mortgage, you do not hand over the deed to your lender. You keep full ownership of the home and are still in full control.
Tax-free proceeds. The Internal Revenue Service does not consider reverse mortgage loan proceeds as income. Therefore, your entire loan proceeds are tax-free.
No effect on Medicare and Social Security. Taking out a reverse mortgage will not affect your Medicare and social security benefits unless your eligibility is based on certain needs. Any change in the availability of funds–not just from a reverse mortgage–may affect your access to these programs.
Protection for heirs. If the home value ends up being less than the loan balance (e.g. when home prices fall), your heirs do not have to pay the difference.
When Will a Reverse Mortgage Be a Smart Choice?
Just like other types of loans, a reverse mortgage is not ideal for everyone. However, it can be a powerful financial tool for the right person.
A reverse mortgage is a smart choice if:
You plan to stay in your home permanently. A reverse mortgage becomes payable when you move away permanently. That said, taking out a reverse mortgage is a good idea if you plan to live in your home for the rest of your life.
You are financially responsible. Loan obligations of a reverse mortgage include paying homeowner’s insurance, property taxes, and keeping the home in good shape. You have to be able to keep up with these requirements to prevent the loan from becoming due.
Furthermore, you have to be financially responsible enough to avoid spending too much of the proceeds too soon. You have to be confident that you can control your spending to avoid outliving the loan. If you want to avoid the temptation of spending too much money, receiving the funds through monthly payments is the best option rather than a lump sum or a line of credit.
You want to grow your line of credit. If you want your line of credit to grow over time, you can choose to leave it untouched. Savvy borrowers take out a reverse mortgage sooner rather than later and allow their line of credit to grow, which gives access to a larger amount of funds in the future.
To learn more about growing a line of credit through a reverse mortgage, read this article here. [insert live link]
Your home’s value is increasing substantially. If your home’s value is increasing by a considerable amount, you may still have extra money for your estate even if you take out a reverse mortgage.
You can communicate clearly with your family. A big concern about reverse mortgages is that estates won’t be able to inherit the home. It is incredibly important that you communicate with your children before you take out a reverse mortgage. They can choose to pay off the loan balance if they want to keep it within the family or they can also refinance the loan. Making these options clear can avoid nasty surprises when you pass away.
Furthermore, a reverse mortgage can keep you financially independent until you die, which means you won’t have to turn to your family or take on additional debt in times of financial difficulties. Stress the importance of this goal to your children when concerns about non-inheritance arise. In fact, using loan proceeds strategically can increase the overall amount of wealth available to your estate when you die.
The Bottom Line
In order for a reverse mortgage to be a smart choice, you have to be a smart borrower. A reverse mortgage is ideal if you can meet the loan obligations and spend the proceeds responsibly. With the right usage of funds, you can secure your retirement and live out the rest of your life comfortably.