For those who have paid off their home or only have a small mortgage, a reverse mortgage may be a way to help cover retirement expenses. A reverse mortgage allows you to borrow against the equity you've built up in your home. By doing so, you can supplement your income and remain in your current home.
What Is a Reverse Mortgage?
A reverse mortgage works differently than a traditional mortgage. With a traditional mortgage, you make payments each month to a lender. If you get a reverse mortgage, the lender makes payments to you. The exact amount you receive will be based on a number of factors, including your age, the current interest rate and the value of your home.
This type of loan is only available to homeowners who are age 62 and older who have built up equity in a home. "A reverse mortgage is a special type of home loan that allows you to convert a portion of the equity in your home into cash," says Katie Ross, education and development manager for American Consumer Credit Counseling in Auburndale, Massachusetts.
With a reverse mortgage, you keep the title to your home. You'll also be required to maintain your home, as well as pay property taxes and homeowners insurance. To be eligible, you must live in the home as your primary residence.
How Does a Reverse Mortgage Work?
If you decide to take out a reverse mortgage, there are several ways you can receive funds from the loan. You might opt for a lump sum, a line of credit, a monthly payment or a combination of these types of payments.
In general, reverse mortgages are known as nonrecourse loans. This means that if you take out this type of mortgage, you won't be responsible for paying the lending institution more than the value of the home. "In most cases, the loan is only paid back when the borrower leaves the home," says Chuck Czajka, founder of Macro Money Concepts in Stuart, Florida. This often takes place by selling the home.
Pros of a Reverse Mortgage
One of the biggest advantages of a reverse mortgage is that it provides a way to cover current expenses. "Money from a reverse mortgage can provide seniors with the financial security they need while allowing them to stay in their home," Ross says. This could help you avoid moving to a smaller, less expensive place.
Another perk is that you won't have to meet the same criteria required by other loans. "There are no credit-worthiness or income requirements," Ross says. If you meet the age guidelines, live in the home and have enough equity, you will typically be able to secure a reverse mortgage.
When you receive funds from the loan, you won't have restrictions on spending the money. "The funds from your reverse mortgage loan can be used for any purpose," says Joseph J. Zoppi, managing partner of Templar Real Estate Enterprises in Princeton, New Jersey.
You also won't have to worry about paying back the loan while you remain in your home. "The homeowner does not need to make any monthly mortgage payments as long as the homeowner lives in the home and continues to meet their obligations," Zoppi says. These will typically include paying the property taxes, maintenance and insurance fees.
Cons of a Reverse Mortgage
A main drawback of a reverse mortgage is that you could have fewer resources to pass on to heirs. The loan balance generally increases over time and interest can accumulate. "You will have less equity in your home that you may want to leave to your children," Ross says.
There are also fees to consider with the loan. You can expect initial expenses such as closing costs, a loan origination fee and an appraisal fee. You will be required to set up a session with a third-party counselor to make sure you understand the loan. In addition, the lender may charge loan servicing fees, and you'll have to pay mortgage insurance premiums. "The fees for a reverse mortgage can be higher than a traditional mortgage," Zoppi says.
Another disadvantage of a reverse mortgage is that by receiving funds from the loan, you might not qualify for some government benefits. "The homeowner's eligibility for certain government programs, such as Medicaid or Supplemental Security Income, may be impacted," Zoppi says.
Making a Decision About a Reverse Mortgage
If you have been planning to leave your home to heirs, a reverse mortgage may not be the right option. "In many cases, the borrower's heirs to the estate are against the reverse mortgage because they see the potential inheritance being depleted due to the accrued interest," says Guy Baker, managing director of Wealth Teams Alliance in Irvine, California. When the loan becomes due, family members would need to provide funds or financing to cover the loan amount at that time. If they can't come up with the funds, they may not be able to keep the home in the family.
If you are short on financial resources, have no family members interested in inheriting your home and no desire to leave your home, a reverse mortgage could fit well for your situation. But a reverse mortgage is not the best choice to seek additional retirement funds for everyone. You could decide to bring in more income through a side business. You might also opt to refinance your existing mortgage, sell the home to your children or downsize to a place in a retirement community.