A reverse mortgage can provide a stream of consistent income for retirement. This type of financial arrangement allows eligible homeowners to convert their equity into income. Unlike a home equity loan or home equity line of credit (HELOC), no repayment is due as long as the homeowner continues to use the property as their primary residence. But is a reverse mortgage a good idea? Let’s compare the pros and cons to help you decide if it makes sense for you.
A financial advisor could help you create a financial plan for your retirement needs and goals.
What Is a Reverse Mortgage?
A reverse mortgage allows eligible homeowners to withdraw equity from their homes, then use it as income during their lifetime. Reverse mortgages accumulate interest and fees, like other types of home equity loans. But there are no monthly payments required for a reverse mortgage.
Instead, a reverse mortgage must be repaid in full once the homeowner is no longer using the home as their primary residence. That can happen if they:
Make a permanent move to long-term care
Get divorced and grant the home to their spouse as part of a settlement
Sell the property
There are some exceptions to this rule for certain types of reverse mortgages. A Home Equity Conversion Mortgage (HECM), for instance, is a type of reverse mortgage that’s backed by the federal government through the Department of Housing and Urban Development.
If you have a HECM and you’re married, your spouse may be able to remain in the home without repaying a reverse mortgage even if you pass away if they’re listed as a co-borrower or as an eligible non-borrower spouse. Once they pass away, then your heirs would be responsible for repaying the reverse mortgage balance.
Advantages of Reverse Mortgages
Reverse mortgages can be attractive to seniors who want to tap into their home equity and turn it into a stream of income for retirement. Depending on how the reverse mortgage is structured, homeowners may be able to receive a lump sum, regular installment payments or a combination of the two. The money from a reverse mortgage can be used to pay day-to-day living expenses, medical bills or cover any other expense.
Since no payment is due as long as the homeowner is living in the home, a reverse mortgage wouldn’t present any additional strain to their budget. With a home equity loan or HELOC, on the other hand, monthly payments would be required. If you’re still paying off the last of your mortgage, having two loan payments to make each month could put pressure on your finances.
Income from a reverse mortgage won’t affect Social Security benefits or Medicare eligibility. Payments you receive, whether in installments or a lump sum, are tax-free. And you also get the benefit of being able to stay in the home.
Disadvantages of Reverse Mortgages
While reverse mortgages could be good for some homeowners, they aren’t necessarily right for everyone. The biggest disadvantage is that even though you can defer payment during your lifetime, a reverse mortgage has to be repaid eventually.
If you plan to leave the home to your adult children when you pass away, they’d be responsible for paying off the reverse mortgage balance. If you haven’t made provision for that by setting aside money in your will or establishing a life insurance policy, they’ll have to produce the money out of pocket. And if they’re unable to do so, they may be forced to sell the home to get rid of the reverse mortgage.
It’s also possible that you could face foreclosure proceedings if you’re not keeping up with certain financial obligations during your lifetime. If you have a home equity conversion mortgage, that means paying your homeowners’ insurance premiums, property taxes and HOA fees. You’re also required to keep up with maintenance and repairs as part of a reverse mortgage agreement.
Is a Reverse Mortgage a Good Idea?
A reverse mortgage could be a good idea if you qualify for one and you’re thinking ahead about how the balance will be paid off when the time comes. Qualification requirements for reverse mortgages from private lenders may vary. If you’re applying for a home equity conversion mortgage, the requirements are very specific. To get this type of reverse mortgage, you must:
Be 62 or older
Own your home outright or have paid off most of the mortgage
Have sufficient financial resources to cover your homeowner’s insurance, property taxes, HOA fees, maintenance, repairs and upkeep
Not be in default on any federal debts
Live in an eligible property and use it as a primary residence
Attend HUD-approved reverse mortgage counseling
Since home equity conversion mortgages are government-backed, they do have private mortgage insurance premiums. You’ll also pay closing costs for a reverse mortgage.
In terms of planning ahead, it’s important to consider every scenario. For example, if you’re married and take out a home equity conversion mortgage, would your spouse be able to stay in the home if you have to enter long-term care? What would happen if you were to pass away?
Life insurance can help you prepare for these kinds of scenarios. You may establish a life insurance policy and name your spouse or children as beneficiaries, with the understanding that the money should be used to pay off the reverse mortgage. That can ensure that the home remains within the family if that’s your wish. You can also make a provision in your will as to what assets should be used to pay off a reverse mortgage balance after you’re gone.
Don't miss out on news that could impact your finances. Get news and tips to make smarter financial decisions with SmartAsset's semi-weekly email. It's 100% free and you can unsubscribe at any time. Sign up today.
Who Should Not Get a Reverse Mortgage?
A reverse mortgage may not be the best option for a few reasons. Specifically, you may want to think twice if you:
Don’t have much equity in the home
Anticipate a move to long-term care at some point
Might want to sell the home
You’d also want to consider a reverse mortgage carefully if someone lives with you. If your spouse is listed as a co-borrower on the loan or as an eligible non-borrower spouse in the case of a home equity conversion mortgage, they wouldn’t be required to vacate the home or pay off the reverse mortgage if something happens to you.
But if your spouse is not listed on the loan as a co-borrower or they’re an ineligible non-borrower then they may be on the hook for the reverse mortgage balance. And if you live with someone else, such as a partner, adult child or grandchild, that could create additional complications with regard to whether they’d be able to stay in the home after you pass away and who would pay the reverse mortgage balance.
A reverse mortgage is something you might consider for retirement planning but it’s important to understand how they work and what you’re agreeing to as a borrower. Also, be sure to keep your spouse and heirs in the loop so there are no surprises should something happen to you.
Mortgage Planning Tips
Consider talking to your financial advisor about whether a reverse mortgage is a good idea for you. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
A reverse mortgage isn’t the only way to access your home equity. You may also consider a home equity loan or HELOC instead. Annuities are another way to create additional income in retirement. With an annuity, you pay premiums to the annuity company and then receive payments back starting at a specified date. Weighing all the possibilities can help you decide on the best ways to supplement retirement savings.
Mortgage rates are more volatile than they have been in a long time. Check out SmartAsset’s mortgage rates table to get a better idea of what the market looks like right now.
Photo credit: ©iStock.com/designer491, ©iStock.com/Tempura, ©iStock.com/AndreyPopov