Reverse Mortgage Pros And Cons: What You Need To Know Before Signing On The Dotted Line

reverse mortgage pros and cons
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Maybe you’ve seen commercials for reverse mortgages.

Or:

Maybe you’ve heard horror stories.

While you may not know much about them, you do know there are reverse mortgages, and with everything, there are goods and bads. Knowing the reverse mortgage pros and cons would go a long way in helping you make a decision.

But first:

You have to know what they are.

Here's the truth:

While it’s true there are some horror stories about reverse mortgages, that doesn't mean they are the wrong choice for you. For some people, a reverse mortgage can be a valuable lifeline during retirement.



The Deets On Reverse Mortgages

A reverse mortgage is a loan against your home. In some respects, it’s similar to a home equity line of credit. Like a home equity line, taking out a reverse mortgage allows you to tap into the equity in your home.

What happens is this:

You borrow an amount of money against your home’s appraised value.

However, unlike a home equity line (or other loan products), reverse mortgages have some unique features. Depending on your circumstances, these features can be positive or negative.

In general, reverse mortgage pros and cons are pretty straightforward.

Pros

The pros of a reverse mortgage are:

  • It allows you to tap into the equity of your house giving you access to cash you may not otherwise have
  • You do not have to make monthly payments during the term of the loan

Cons

The cons of a reverse mortgage are:

  • While there are no monthly payments to make during the loan term, interest continues to accrue
  • When the loan comes due, the total amount of the loan (principal plus interest) is due in full

But, here's the thing:

Once you start digging into the specific details of reverse mortgages, you’ll find reverse mortgage pros and cons are far more complex than just these few points.



3 Types Of Reverse Mortgage

There are three different types of reverse mortgages.

1

Home equity conversion mortgage

Seniors walking

Seniors frequently consider a reverse mortgage to fund retirement. Image via Pixabay

home equity conversion mortgage (HECM) is the most common type of reverse mortgage. HECM reverse mortgage pros and cons include:

Pros

  • The loan is federally insured by the U.S. Department of Housing and Urban Development (HUD)
  • It has no income limits or medical requirements
  • You can use the mortgage funds to pay for anything

Cons

The cons of a reverse mortgage are:

  • You must go through mandatory counseling before you can apply for the reverse mortgage and you will have to pay a small fee for the session
  • You will have to prove that you have sufficient assets to pay for certain items such as property taxes and home insurance
  • The amount you can qualify for and borrow is limited

2

Single-purpose reverse mortgage

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Here's the glitch with a single-purpose reverse mortgage:

You can only use the funds for a single purpose that the lender approves.

For example, if you need a new roof and don’t have the funds available to pay for it, you can take out a single-purpose mortgage, but only to pay for that new roof.

While you could take out a regular home equity loan to pay for this repair, you would have to make regular monthly payments once the loan commences.

Here's the good news:

With a single-purpose reverse mortgage, the loan does not have to be repaid until the home is sold or the borrower dies.

However, if you choose to use the funds to pay for something other than the approved purpose and the lender finds out, you will be in default of the mortgage.

And the bad news is:

At that point, the lender will have the right to seize your home.

3

Proprietary reverse mortgage

Clock and money

The equity in your home increases over time. Image via Pixabay

Because the amount of money you can borrow with a HECM loan is capped, if your home appraises at a high value, you may not be able to borrow as much money as you could with a traditional mortgage refinance or a HELOC.

In that case:

You could consider a proprietary reverse mortgage as these products do not have dollar caps (but they do have percentage caps).

Reverse mortgage pros and cons for a proprietary mortgage are the same as a HECM loan with one exception.

While you can borrow more money than you could with a HECM loan, the loan is not federally insured. Therefore, the lender may charge you higher fees to make up for the lack of federal insurance.



When To Consider A Reverse Mortgage

While there are some who say you should only take out a reverse mortgage as a last resort, there are times when a reverse mortgage could make sense.


Consider taking out a reverse mortgage only if:

  • The primary borrower doesn’t plan on moving for at least five years
  • You can afford to pay for property taxes, insurance, and maintaining the home
  • You will use the funds as a source of long-term cash, not for a short-term emergency


How To Qualify For A Reverse Mortgage

building-o

The fact is:

Not every homeowner will qualify for a reverse mortgage.

Reverse mortgage pros and cons include the fact that there are certain rules every reverse mortgage must comply with.


On top of that:

On top of that:

Every lender must consider the specific circumstances of each applicant before issuing the loan.

Your age

Reverse mortgage pros and cons include the borrower’s age. In order to take out a reverse mortgage, you must be at least 62 years old.


No exceptions.


The older you are when you apply for the reverse mortgage, the more money you will be able to borrow.


If both spouses of a married couple are going to borrow, only one of them must be 62. However, to determine the overall amount you can borrow, lenders must look at the age of the younger spouse.


Age a factor because:


Senior couple

Image via Pixabay


HUD determines
 the amount a bank can loan. Furthermore, HUD assumes that a younger borrower will live longer. Because reverse mortgage pros and cons include the fact that no payments are necessary to help pay down the principal, the loan will always grow as it accrues interest.

More money at the back end for the lender.

But, since HUD assumes that a younger person will live longer, which could cause the loan to grow to a size that may be unmanageable by the time the loan is due, they limit the amount a younger borrower can access to help limit the overall cost of the loan.

Age

Home
Value

Mortgage
Balance

Available
Principal

62

$300,000

$0

$185,700

75

$300,000

$0

$207,900

85

$300,000

$0

$224,100

You need to own (most) of the home

Image via Pixabay

In general, to qualify for any reverse mortgage, you need to own the home outright.

On the flip side:


If you have an existing mortgage, that’s OK. You can still qualify for a reverse mortgage. But, you’ll need to have at least 40 to 50 percent equity in the home to do so.

It has to be your primary residence

The pros and cons of reverse mortgages include a residency requirement.

In order to comply with the loan terms:

The home you take the reverse mortgage on must be your primary residence.

For a reverse mortgage, a primary residence is defined as:

family home -- primary residence

Image via Pixabay

A home in which you reside for a majority (more than 50 percent) of the year


As long as you reside in the home for at least six months out of the year, you are meeting the residency requirement.


But that's not all:

If you have to move out for 12 or more consecutive months -- for any reason -- your home is no longer considered your primary residence, and the loan comes due.

Income requirements

calculator to figure out reverse mortgage

Image via Pixabay

While you are likely tapping into your home’s equity because you need additional cash, you still have to prove you can pay for certain expenses independent of the reverse mortgage funds you may receive.

These additional expenses are required include:

  • Property taxes
  • Maintenance and upkeep (like a new roof, the HVAC system, and even lawn care)
  • Homeowners insurance

If you cannot prove that you can keep up with these expenses, you likely will not be eligible for a reverse mortgage.



Reverse Mortgage Pros And Cons

While there are pros and cons to every loan, reverse mortgage pros and cons are specific and unique.

Here's a warning:

Before you sign on the dotted line, consider these pros and cons.

Reverse Mortgage Pros

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The pros generally center around the fact that you do not have to make any payments on the loan. However, there are some additional pros to think about when considering a reverse mortgage.

It pays you

What's unique about a reverse mortgage is that it pays you to live in your house. It's kind of like a stipend. You can choose to revive a lump sum payment.

Or, you can do this:

Chose to receive regular monthly payments (like a salary).

Can pay fees out of the loan

What's unique about a reverse mortgage is that it pays you to live in your house. It's kind of like a stipend. You can choose to revive a lump sum payment.

Or, you can do this:

Chose to receive regular monthly payments (like a salary).

Image via Rawpixel

The payments may not count as income

In some cases, the payments you receive from a reverse mortgage may not be considered taxable income.

And here's an added bonus:

Because they may not be considered taxable income, they may not affect other benefits you receive (like Social Security or Medicaid).

But you should consult with your accountant to review your specific situation.

It’s a non-recourse loan

A non-recourse loan is a loan that is secured by collateral. In the case of a reverse mortgage, the collateral is the house. However, as a non-recourse loan, there are still some reverse mortgage pros and cons to know about.


Should you default on the loan, the lender can seize your property.

That’s why it’s so important to keep to the terms of the agreement. If the house is seized, the lender is likely to sell it to recoup their losses.

But there is some good news:

Should the house sell for less than the amount due on the loan, the lender cannot come after you (or your heirs) for the difference.

It does not matter if the house was seized because you are in default, or if the loan is coming due under the regular terms of the mortgage.

Say you take out a reverse mortgage for $175,000. Because you don’t have to make any payments during the life of the mortgage, that amount grows because you are being charged interest. Let’s say the total amount you owe comes to $225,000 (principal plus interest).

If the house is seized, the lender will sell it. However, they only get $200,000 for the house, meaning they lose $25,000. Because this is a non-recourse loan, the lenders can’t go to court and sue for the $25,000 they lost.

Reverse Mortgage Cons

Residential neighborhood

Image via Pixabay

Of course, for all the pros to a reverse mortgage, there are some cons you should examine before choosing this road.

Strict rules

Reverse mortgages have a very specific set of rules that the borrower must follow. They are unlike the rules of a regular mortgage or even a line of credit.

Here's what you have to know:

The rules can include things like staying current on your homeowner’s association dues (if you have them), or taking care of the lawn. Failure to follow the rules could put you in default.

While the full loan amount is generally not due until you die (or move out permanently) if you default on the loan at any time by not following the rules, the bank can seize your home and force you to move out.

Remember this:

Even though you retain the title to your home, you’ve used the house as collateral for the reverse mortgage, giving the bank the right to seize it.

You still need some cash on hand to qualify

Reverse mortgage pros and cons include the fact that you have to prove you can still pay for certain items out of pocket.

Can't prove it? No load for you.

And here's the kicker:

If you do have sufficient income when you apply for the loan, but that changes later, you still have to pay for the required items. If the bank finds out you’ve fallen behind on insurance payments or you need to make repairs and haven’t, you could be in default of the loan.

You still accrue interest

While you don’t have to make monthly payments on the loan, the balance is always growing. It doesn’t matter if you chose to take a lump sum payment, a fixed monthly payment, or even use it as a line of credit.

The loan is still accruing interest. This interest accrual contributes to the final payoff amount being larger than the initial loan amount.

Consider this when weighing reverse mortgage pros and cons:

The loan isn’t due until you either die or move out. However, there is no good way to predict when this will happen. Therefore, there’s no way to predict the final payoff amount.

Can’t borrow as much as you might want

Included in reverse mortgage pros and cons is that the total amount available for you to borrow will vary due to certain factors outside your control.

This includes:

1. The appraisal of your house
2. Interest rates
3. And a few other factors.

However, even if you could control these factors:

You are still limited in what you can borrow.

Federal rules state: You can only borrow up to 60 percent of the appraised value of the home.

That’s meant to protect you as much as it is the lenders. And, if it’s a HUD insured loan, there’s a cap on the total dollar amount you can borrow regardless of what the total percent is.

You can use a proprietary mortgage in that case, but you can still only borrow up to 60 percent of the appraised value.

It can affect your estate

This is kind of tricky.

When you die, the reverse mortgage becomes due.

In full.


That’s the entire principal plus any interest owed.

At this point, your heirs have to pay off the full loan. There are several ways they could do this.

  • They could buy the house from the bank, assuming they make a fair offer for it
  • Or sell the house on the open market
  • They can also pay off the loan in full (and in cash)

Your heirs do not have to do anything right away. They have six months to decide what they want to do and how they want to do it.

Here's something to think about:

If your intent is to leave the house to your heirs, you won’t necessarily be able to do this with a reverse mortgage.

Technically, your heirs could buy the house, but this may not always be possible. And, because the house is collateral on the reverse mortgage, there’s no way to leave it to them in the will.

The pros and cons of reverse mortgages in this case are:

  • If your heirs choose to sell the house and it sells for less than the total loan amount due, your heirs and your estate are off the hook for the difference
  • If you want to leave the house to your heirs and they cannot afford to pay off the loan, there’s no way for them to inherit the house
  • If your heirs choose to sell the house and it sells for less than the total loan amount due, your heirs and your estate are off the hook for the difference
  • If you want to leave the house to your heirs and they cannot afford to pay off the loan, there’s no way for them to inherit the house

It’s complicated when it’s not just you

Reverse mortgage pros and cons include the rules that govern these mortgages. While it may be hard to think of rules as a pro, some of them exist to help protect the borrower.

But if you don’t own the home:

Not all of these protections extend to you.

If you have children or a roommate and the borrower dies or moves out, these people do not necessarily have the right to stay in the home. In general, they will have six months to either buy the home or move out.

Image via Pexels

Special rules for married couples

For the sake of simplicity, we’re only going to talk about HECM mortgages.

If both parties are listed on the mortgage documents as borrowers, then they are treated equally by the lender.

This is important because:

If you recall, you are required to live in the home for 12 consecutive months in order to keep the reverse mortgage. If you have to move to a nursing home, the loan becomes due.

However, in the case of a married couple that are both borrowers, if only one spouse moves to the nursing home, the other spouse can remain in the house and continue with the reverse mortgage.


Everything remains the same until the second spouse dies or moves out.

If only one spouse is listed on the documents as the borrower, things get a little more complicated.

Before August 2014, if the borrowing spouse died or moved out of the house for any reason, the non-borrowing spouse had no guaranteed rights to remain in the home. The remaining spouse had six months to either pay off the loan or move out.

But here's the deal for after that date:

For reverse mortgages starting after August 2014, if the borrowing spouse left the home or died, the reverse mortgage can continue without repayment if these criteria are met:

When the loan started, the non-borrower was legally married to the borrower
That person is named as a spouse in the HECM documents
The borrowing spouse must annually certify that the non-borrowing spouse is eligible per the HECM documents



Alternatives To A Reverse Mortgage

Because of the number of reverse mortgage pros and cons, a reverse mortgage may not be the right choice for you.

If you still need cash, there are other options to consider.

Refinance

Depending on your situation, it may be possible to refinance your existing mortgage. That may allow you to take out much-needed cash.

And here's the best part:

You could get a lower interest rate on your mortgage.

An added benefit is that should you move out or die, the loan will not necessarily come due immediately. Your heirs can continue to make payments on the mortgage and take as much time as they need to decide what to do.

Stately New England Home

Image via Pixabay

Open a line of credit

Couple getting new home keys

Image via Pexels

In many ways, a home equity line of credit (HELOC) is similar to a reverse mortgage.

Here's why:

You’re tapping into your home’s equity and using it only if and when you need to.

The advantage of a HELOC is that you can take what you what when you want it.

But here's the rub:

Once you borrow against that line, you will need to pay it back regularly, just like any other loan.

Sell

It’s not easy for everyone to let go, but:

Selling the home can free up the cash you need.

Moving someplace smaller and less expensive may help preserve that cash and help cut back on expenses as well.

Make the kids your landlord

One unique possibility is to sell the home to your kids and rent it back from them. While they would have to buy the house (and probably take on a mortgage), as a landlord, the kids would be able to collect rent from you and use it as a deduction on their taxes.

Use caution though:

An arrangement like this may not be suitable for everyone. Discussing all the pros and cons and writing it down (perhaps with the help of an attorney) is a wise choice for this scenario.

Foggy Bottom townhomes

Image via Pixabay



Reverse Mortgages: The Pros Might Outweigh The Cons

Before you sign:

Discuss reverse mortgage pros and cons with a qualified real estate attorney.

In addition to that:

Florida home

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Make sure to explore every alternative that is available to you as a homeowner.

Of course, the pros and cons of every loan product will vary depending on your specific situation. However, once you’ve educated yourself, you’ll be able to make an informed choice about whether or not a reverse mortgage is right for you.

Do you have any experience with reverse home mortgages? Share your knowledge in the comments and help others!

Featured Image: CC0 via Pixabay