What Is a Reverse Mortgage?
Point of Interest
A reverse mortgage, which allows you to refinance your mortgage to access cash if you’re over the age of 62, is a useful tool when used as part of your retirement plan. Still, it’s wise to consider the pros and cons before you rely on it to get you through your golden years.
If you find yourself wondering, “What is a reverse mortgage?” you aren’t alone. Basically, a reverse mortgage is an equity loan that allows homeowners ages 62 and over to refinance their mortgage and get access to a lump sum of cash in return, which won’t have to be paid back during their lifetime.
A reverse mortgage is a mortgage loan secured against your home and its value. This type of mortgage allows you to tap into your home’s equity and receive cash in return without having to make monthly payments like a typical mortgage. Interest will accrue as it does with any loan; however, the final repayment of the reverse mortgage is only due when the borrower has vacated the home permanently.
This type of mortgage can help seniors who are struggling to pay their bills after they retire. Many senior homeowners take advantage of this type of refinancing due to the low interest rates and increased housing prices in today’s market. There are several interesting pros and cons for this type of mortgage, including who should use it and who might want to look elsewhere.
What is a reverse mortgage?
A reverse mortgage is basically an interesting take on an equity loan and can offer a lot of benefits when used properly. This type of mortgage allows you to convert part of the equity in your home into cash without having to sell your home or pay additional monthly bills. You’ll draw out the equity in your property earlier than you normally would, but in return, your interest and balance will accrue over time.
These debts aren’t paid back monthly like a typical mortgage loan, though. They’re paid back when you either a.) sell your home and move, b.) you pass away and your home is sold by your heirs, or c.) the loan is paid off by your heirs after you pass in return for the deed to the house.
There are several types of reverse mortgages, including single-purpose, proprietary and home equity conversion mortgages, or HECMs. These loans are offered by private lenders like Liberty Home Solutions or American Advisors Group (AAG), among others. The Federal Housing Administration (FHA) insures all reverse mortgages, though, which means you must pay for insurance — even if you don’t have a monthly mortgage payment.
Reverse mortgage pros and cons
Before applying for a loan like an AAG reverse mortgage, think about the pros and cons of taking that step on your wider financial future. Reverse mortgages aren’t immune from risks, so you need to be prepared for the possible consequences.
- Money received is tax-free — When you get cash back for your reverse mortgage, you don’t have to pay taxes on it.
- Steady stream of income — You can get part of the equity you have put into your home over the years back as spendable funds, either in the form of a lump sum, a line of credit or monthly payments.
- You continue to own the home — If you’re worried about having to sell your home because you are unable to make your mortgage payments, a reverse mortgage can help you stay in your home without giving up ownership.
- Won’t pay interest on unused funds from the line of credit — If you choose to pull out the funds into a line of credit, you don’t have to pay interest on money if you don’t use it.
- Your heir doesn’t have to take on debt — A reverse mortgage is a “non-recourse loan,” so you can’t owe more on the loan than your house is worth. Plus, your children aren’t on the line for the debt if they opt out of it.
- Cheaper than moving — While you may have to pay some costs with a reverse mortgage, for many people, these fees are cheaper than the costs associated with moving.
- Mismanagement of funds — People selling reverse mortgages may convince you it’s a good idea to use a reverse mortgage to pay for a home renovation or buy other financial products. These aren’t the best uses for this type of loan.
- Possible fees — Just like when you close on a conventional mortgage, you’ll pay closing costs and other fees to obtain the loan. These fees may counteract the benefits you receive, making them negligible.
- Foreclosure — If you fail to pay your property taxes, HOA fees or maintain your home, you could face losing your home. Although you don’t have to pay your mortgage, you’ll still have other payments you’re responsible for.
- Interest rates — You can choose a reverse mortgage with a fixed or variable interest rate, but your choice may not be the best option for you in the long run.
- Losing valuable property if the heir isn’t willing to take on debt — After you pass away, if your heir isn’t willing to take on debt, they will have to turn the property over to the state, which means the property won’t stay in your family.
- Complicated legality — Reverse mortgages can be tricky, especially in cases where the borrower dies after a big life event, such as marrying a new spouse. If this happens, you may need to consult with a lawyer to figure out what the next step is.
When should you get a reverse mortgage?
It’s a big decision to decide to take out a new mortgage. You may think the low mortgage rates and sky-high housing prices mean now is the right time, but it all depends on what works for your specific retirement plan.
First, you need to meet the minimum requirements to be able to qualify for a reverse mortgage, including:
- 62+ years old
- Live in the home
- Mortgage loan must be paid in full or have a very low balance
- Aren’t delinquent on federal debts like student loans or income taxes
- Must pay for closing costs like insurance and property taxes
- House is in good condition
- Can attend the required U.S. Department of Housing and Urban Development mortgage counseling
Keep in mind that even if you choose a reverse mortgage as one part of your retirement plan, you might still need other sources of income. You’ll also need to be able to pay for property taxes, homeowners insurance and keep the home properly maintained. Plus, the debt in your name still increases because the money will have to be repaid eventually, even if you aren’t the one stuck making those payments every month.
The final word
A reverse mortgage is a potentially handy tool you can apply to your overall retirement plan to help you make the most of your golden years. Just keep in mind the risks and possible consequences before applying to refinance using this type of loan. Otherwise, it could burden you or the person who is handling your finances after you’re gone with a ton of hassle and debt.