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With a reverse mortgage, an older homeowner with significant equity—at least 50%—can borrow money against the value of their house without having to make regular payments. When you take out a reverse mortgage, the lender pays you, unlike a conventional (“forward”) mortgage in which you pay the lender. But is this arrangement too good to be true?
We’ll go into detail about the benefits and drawbacks of reverse mortgages to help you decide if one is right for you.
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Note from the Editor: This article’s content is solely based on the author’s opinions and suggestions. It might not have received approval from any of our network partners through reviews, commissions, or other means.
With a reverse mortgage, an older homeowner with significant equity—at least 50%—can borrow money against the value of their house without having to make regular payments. When you take out a reverse mortgage, the lender pays you, unlike a conventional (“forward”) mortgage in which you pay the lender. But is this arrangement too good to be true?
We’ll go into detail about the benefits and drawbacks of reverse mortgages to help you decide if one is right for you.
Pros and cons of a reverse mortgage
Due to recent mortgage industry frauds, you might be unsure if a reverse mortgage is a good idea or concerned that they’re just a rip-off. Although reverse mortgages are a reputable financial product, not everyone should use them.
There are various types of reverse mortgages; here, we’ll concentrate on the Federal Housing Administration (FHA)-backed home equity conversion mortgage (HECM) program. Below, we’ve outlined the main benefits and drawbacks of reverse mortgages to assist you in deciding whether this loan product might be suitable for you:
Pros: The perks of a reverse mortgage
You can stay in your home longer. As you get older, you have more options for meeting your changing financial needs thanks to equity’s flexible options. For instance, a reverse mortgage may make aging in place improvements more affordable than downsizing and selling your house.
You can add to your retirement income. If you decide to get payments from your reverse mortgage every month, you’ll have a steady stream of money coming into your budget.
You can pay off debt. You can settle any outstanding balances with a lump-sum distribution if you have unpaid medical bills or high-interest debt.
You can leave other retirement accounts alone. You may be able to avoid early withdrawal penalties from other retirement accounts by taking income from a reverse mortgage.
You’ll have more financial freedom. The flexibility of a reverse loan allows you to do the things that are important to you and your family. As you or a loved one ages, you can assist a child with college expenses or remodel your home to accommodate special needs.
Your reverse income is not taxed. Reverse mortgage payments aren’t taxable because the IRS doesn’t classify them as income, so you can receive them as a lump sum, monthly income, a line of credit, or any combination of the three.
You won’t leave an underwater home to your heirs. Reverse loans have built-in safeguards that restrict your heirs’ liability for any outstanding balance following your passing.
You don’t have to meet debt-to-income (DTI) ratio requirements. No mortgage payment means less income is needed to qualify. However, a lender must confirm that you can make your homeowners insurance, property tax, and, if applicable, homeowners association (HOA) payments on time.
After your passing, your spouse can either remain in the house or leave. If you were married when you took out the reverse mortgage, even if they weren’t a co-borrower, they can remain in the house after you pass away or move into a long-term care facility. However, they must meet certain conditions set by the U. S. Department of Housing and Urban Development (HUD).
Cons: The downsides of a reverse mortgage
Your home’s equity will shrink. The loss of home equity is one of reverse mortgages’ major drawbacks. You’ll make less money when you sell the property or have less borrowing power if you need a new loan because you’re not reducing the balance of your reverse mortgage.
You’ll pay high upfront fees. Reverse mortgages are more expensive than other home loan types due to loan origination fees of up to $6,000, upfront mortgage insurance premiums equal to 2% of your home’s value, and other closing costs.
You may be disqualified from other income benefits. Before deciding how to receive your funds, speak with a financial planner or attorney. Why? Receiving reverse loan funds may affect your eligibility for Medicaid or Supplemental Security Income (SSI).
You’ll reduce your heirs’ inheritance. Your heirs would receive less equity as a reverse mortgage balance increases. When you die or move, they won’t be able to keep the house if they are unable to pay back the loan.
You might lose your home to foreclosure. Insurance and property taxes are still your responsibility, and if you don’t pay them on time, you risk having your house foreclosed upon. If you are unable to live in your home for more than 12 months in a row due to health problems, a reverse mortgage lender may foreclose on the property.
A reverse loan cannot be used for investment or vacation properties. To be eligible for a reverse mortgage, you must demonstrate that you are residing in the property you are financing.
Throughout the term of the loan, you won’t receive a tax benefit. Before the entire or part of the outstanding balance is repaid, the interest on a reverse mortgage is not tax deductible.
How much money do you get from a reverse mortgage?
Your ability to borrow money is determined by the specific reverse mortgage product you select, the lender, and an evaluation of your circumstances, including your age and the value of your home. The highest amount you can get in 2022 with a HECM loan, the only reverse mortgage loan type backed by the federal government, is $970,800.
To determine how much of a lump sum you might be eligible for, use LendingTree’s reverse mortgage calculator; for other payout types that require more complicated calculations, speak with a lender or housing counselor.
Like all mortgages, there are a number of factors that determine who qualifies and what loan terms are offered. However, reverse mortgages don’t have minimum requirements for credit score or income, unlike conventional forward mortgages. However, there are still requirements for the following:
Reverse mortgages vs. traditional mortgages
Reverse mortgages are both very similar to and very different from conventional mortgages in the following ways:
How reverse mortgages are the same as traditional mortgages
→ Your loan is secured by your home
Your new mortgage cancels any outstanding home loans that you may have.
You must keep up with your payments for property taxes, homeowners insurance, and HOA dues.
→ You’ll need to maintain your home
→ Fixed and variable interest rates are available
How reverse mortgages are different from traditional mortgages
You have three options for receiving your money: a lump sum, monthly payments, or a line of credit.
You don’t have to start paying until you vacate the property or pass away.
As long as you have the loan, your equity will decline.
Who is a reverse mortgage right for?
Here are a few general guidelines to help you determine whether a reverse mortgage is appropriate for your circumstances.
A reverse mortgage may be a good idea if:
A reverse mortgage is likely a bad idea if:
Alternatives to a reverse mortgage
Contrary to popular belief, a reverse mortgage is not the only way to borrow money against the value of your home. In recent years, reverse mortgages have actually occasionally been the least preferred way for homeowners to access their home equity. Instead, they had chosen in greater numbers home equity loans, cash-out refinances, and home equity lines of credit (HELOCs). However, each of these loans has different requirements, loan limits, and monthly costs to take into account.
Here is a quick comparison of these loan types to a reverse mortgage, but for a more thorough analysis, see our comparison of reverse mortgages, home equity loans, and HELOCs.
Reverse mortgage vs. home equity loan
A home equity loan, also referred to as a “second mortgage,” is a lump-sum loan equal to up to 85% of the value of your home that you must repay over time in fixed payments at a fixed rate. A home equity loan has stricter income and credit requirements than a reverse mortgage, making it more challenging to be approved for one. The minimum credit score needed for a home equity loan is 620, and there must be 15% equity in the home.
Reverse mortgage vs. HELOC
Another kind of second mortgage is a HELOC, which functions more like a credit card that is secured by your house rather than paying out a lump sum. Within the “draw period,” which is a predetermined time frame in which you are only required to make interest payments, you can access your credit line whenever you want. This draw period typically lasts 10 years. They have income, credit, and other requirements like home equity loans, making them less available to borrowers with low incomes or poor credit than reverse mortgages.
Reverse mortgage vs. cash-out refinance
A cash-out refinance is when you take out a new mortgage that is higher than the amount of your current mortgage so that you can keep the difference in cash. One benefit of a cash-out refinance is that, unlike a reverse mortgage, it won’t cause your equity to steadily decrease over the course of your loan.
Loans from private lenders that exceed the “maximum claim amount” established by the FHA for their HECM program are referred to as jumbo reverse mortgages. In 2022, this amount is $970,800.
Refinancing a reverse mortgage is possible, and there are a variety of reasons why borrowers might want to do so, including improving interest rates, including a spouse in the loan, or assisting the heirs of a deceased homeowner in keeping their home.
Lenders don’t require homeowners to make monthly payments on their reverse mortgage loan while they are still alive and residing in the property. But the entire loan balance will become due the moment the homeowner passes away. The home is frequently sold by the surviving family members to pay off this loan, but if they want to keep it, they can pay off the loan balance in cash. They can refinance their current reverse mortgage if they can’t access enough cash to pay off the entire loan balance.
Even though reverse mortgages are a reputable financial product, you should be aware of the very real phenomenon of reverse mortgage scams. Tom Selleck frequently appears in commercials for American Advisors Group, which was recently fined $1 by the Consumer Financial Protection Bureau (CFPB). 1 million for using deceptive marketing tactics.
The good news is that most reverse mortgages give you the right to change your mind without having to pay any penalties. As long as you take the proper steps to cancel the transaction within three business days of closing, the lender is required to refund any money you put toward obtaining the loan.
Compare Mortgage Loan Offers Loan type:
Although it can be a helpful tool, borrowing against the equity in your home carries some risks. Understand the pros and cons of a home equity loan.
A HELOC is a credit line that enables you to draw money as needed by borrowing against the equity in your home.
Understanding home equity products will help you leverage your equity wisely and prevent expensive mistakes.
FAQ
What is the downside of getting a reverse mortgage?
The loss of home equity is one of reverse mortgages’ major drawbacks. You’ll make less money when you sell the property or have less borrowing power if you need a new loan because you’re not reducing the balance of your reverse mortgage. You’ll pay high upfront fees.
What does Suze Orman say about reverse mortgages?
There is no one size fits all solution. Although a reverse mortgage won’t be everyone’s best option, it shouldn’t be disregarded as a component of their overall retirement strategy.
Why do people dislike reverse mortgages?
Because reverse mortgages are negatively amortized loans, which means that the loan balance increases over time, some people might not like them. This differs from a traditional mortgage, which has a decreasing loan balance as borrowers make monthly payments.
Who benefits most from a reverse mortgage?
The best candidates for a reverse mortgage are those with little or no remaining principal on their initial mortgage and long-term homeowners (more than five years). Jason Adler of the Federal Trade Commission advised consumers to “do their homework, compare prices, and speak with a federally certified housing counselor.”