Is a reverse mortgage a good idea?
While reverse mortgages can be a handy way to access cash in your twilight years, they also come with some significant risks and aren't right for everyone. Are you thinking about taking out a reverse mortgage on your house? Here's when a reverse mortgage could be a good idea and when you may want to explore alternative options.
In this article:
Reverse mortgages: How do they work?
When is a reverse mortgage a good idea for seniors?
When is a reverse mortgage a bad idea?
Reverse mortgage warnings and scams
Alternatives to reverse mortgages
FAQs
Reverse mortgages are a type of loan designed for older homeowners. They allow you to borrow from the equity you've built up in your home and turn it into cash, much like a home equity loan or HELOC.
As the name suggests, these loans work in 'reverse' compared to traditional mortgages. Instead of you paying the lender each month, the reverse mortgage lender pays you out of your home equity. You can choose to receive these funds as regular monthly payments, an extended line of credit, or a lump sum payment.
Either way, you won't need to repay the reverse mortgage until you sell the home, move out permanently, or pass away — in which case, your heirs will need to pay off the outstanding loan balance, usually by selling the property.
The most common type of reverse mortgage loan is a home equity conversion mortgage (HECM), which is backed by the Federal Housing Administration (FHA). You must be at least 62 years old to qualify for these mortgage loans. But you can qualify at age 55 with a proprietary reverse mortgage, which is offered by private lenders.
Since reverse mortgages don't require monthly mortgage payments, they can be helpful for senior citizens who want to reduce their household costs.
They also allow you to age in place rather than moving into a nursing home or assisted living facility. You can do so without dealing with a costly mortgage payment, and they can give you a steady stream of income at a time when you have limited earnings. This can be helpful if you're only relying on Social Security or have minimal retirement savings to pull from.
Reverse mortgages require you to have a lot of home equity, though (usually 50%, according to reverse mortgage lender Finance of America), so if you don't have enough built up, it may not be an option. You must also have the funds to keep up with home maintenance, property taxes, and home insurance coverage. If you can't, the lender could foreclose on your property. Finally, if you still have a balance on your original loan, you will need to pay that off or use your reverse mortgage funds to do so at closing.
A reverse mortgage can be a helpful financial tool, but only for the right homeowners. As with any financial product, a reverse mortgage has its pros and cons. If you're not sure you'll have the funds to cover your property taxes, homeowners insurance, and home maintenance costs for the long haul, you should explore other options so you don't lose your house to foreclosure.
A reverse mortgage isn't a great idea if you don't plan to stay in your home for long. It can deplete your equity quickly — especially if you still have an existing mortgage on your house — and drastically reduce your profits when you eventually sell the home.
The same applies if you're looking to leave behind a hefty estate for your heirs: A reverse mortgage could significantly reduce what you're able to bequeath them while also saddling them with the hassle and headache of having to settle your debt.
For the most part, reverse mortgages are safe. But there are always scammers out there. If you're considering a reverse mortgage, you should be on the lookout for potential scams and fraud.
According to the Consumer Financial Protection Bureau and the Department of Housing and Urban Development's Office of Inspector General, this could look like one of the following scenarios:
A friend or family member coercing you to apply for a reverse mortgage
Someone using your identity to apply for a reverse mortgage in your name without your knowledge
Contractors trying to convince you that a reverse mortgage is the best way to pay for a home renovation — or that a particular renovation is necessary in the first place
Someone asking you to sign a power of attorney over to them to access your reverse mortgage funds
High-pressure sales tactics from lenders
Pushing you to use your reverse mortgage proceeds to purchase annuities or investments
If you suspect a potential scam is happening, report it to the Federal Trade Commission, the CFPB, your state's attorney general, or your state's banking regulatory agency.
Reverse mortgages aren't the only way you can access money if you need it as you age. If you're looking to tap the equity you have in your home, you can use a home equity loan, home equity line of credit (HELOC), or cash-out refinance. All of these let borrowers turn home equity into cash, but unlike a reverse mortgage, they all require you to make monthly payments at some point.
You could also sell your home and downsize to a smaller place to reduce your monthly payment and cash in on some of the equity you've built up in the property. Alternatively, you could rent out some of the extra rooms in your home. This would create extra monthly income you could use to support yourself in retirement.
Dig deeper: Reverse mortgage vs. home equity loan vs. HELOC — Which is best?
The biggest problem with a reverse mortgage is that it can lead to foreclosure if you don't stay on top of your property taxes, home insurance, and home maintenance. It also depletes your equity quickly and can leave you little to pass down to your heirs.
The biggest benefit of a reverse mortgage is that it allows you to turn your home equity into cash and eliminates your monthly housing payments. This can be very helpful in retirement, when you're on a limited income.
Yes, you can lose your home with a reverse mortgage. This would happen if you fail to stay current on property taxes, home maintenance, and home insurance.
Laura Grace Tarpley edited this article.
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