Reverse mortgages: Exploring the pros and cons for seniors

As pensions continue to be phased out in most industries, more and more retirees are relying on Social Security benefits that often do not cover all of their expenses. Unfortunately, there may be seniors who don’t realize that they have an additional asset at their disposal - their home. Some of these adults don't know that they can use their homes to fund their retirement with a reverse mortgage, as long as they’re 62 or older.

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However, deciding whether a reverse mortgage is a good idea can be a complex decision — it's crucial to weigh the benefits against potential drawbacks. Read below to learn how a reverse mortgage works, when a reverse mortgage is a good idea and if a reverse mortgage is worth it for you.

What is a reverse mortgage?

If you own your own home or have a very low mortgage balance, you may qualify for a reverse mortgage. A reverse mortgage is a type of loan where the lender pays you a certain amount from the equity you’ve accrued. This can come in the form of a lump sum, a monthly payment or a line of credit, depending on the agreement. 

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Every month, you will accrue fees and interest that will not be due until you pass away or sell the house. After you no longer live in the home or pass away, the balance will be due. When that happens, the estate will be responsible for coming up with the funds to pay off the loan, usually by selling the home. 

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The home will always remain legally in your name while you have a reverse mortgage. You can only use a reverse mortgage on a primary residence. If you have a vacation home or rental property, you cannot take a reverse mortgage. If you change your mind about opening a reverse mortgage, you can cancel it within three days and receive your closing costs back from the lender.

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Most seniors use reverse mortgages to cover the gap between their income and their expenses. They may also use the funds to pay for a child’s or grandchild’s college education, remodel their home to make it more senior-friendly, or to cover medical bills and other expenses.

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Because you are allowed to stay in your home for as long as possible, your home’s value may drop below the amount of the reverse mortgage fees. This can also occur if your home’s value drops after taking out a reverse mortgage. 

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In most cases, there will be no penalty if the balance is larger than what your home sells for. In this instance, the mortgage insurance company will pay the difference between the home’s value and the reverse mortgage balance.

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Unlike other types of loans, reverse mortgages do not have minimum credit score requirements. This is a huge perk for seniors with bad credit or no recent credit history.

Types of reverse mortgages

HECMs

A Home Equity Conversion Mortgage (HECM) is the most common type of reverse mortgage. The HECM is insured by the Federal Housing Authority (FHA), the same federal organization that offers FHA mortgages.  

Proprietary

A proprietary reverse mortgage is similar to an HECM, but is offered by a private lender and not the FHA. Proprietary reverse mortgages are often needed by homeowners with large home values. These reverse mortgages usually have higher interest rates than HECMs, but can offer more money to the homeowner than HECMs.

Single-purpose reverse mortgage

A single-purpose reverse mortgage is given by a state or local organization. Like it sounds, this type of reverse mortgage can only be used for a particular reason. This may include covering necessary home repairs or paying expensive property taxes.

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This kind of reverse mortgage is usually less expensive, which can be a benefit for the homeowner who doesn’t need a large sum of money.

Reverse mortgage pros and cons

Here's an overview of the pros and cons of reverse mortgages:

Pros

• Stay in your home: A home is the largest asset that most seniors possess. And while many are happy to sell their home and downsize, others want to grow old in the same residence they’ve had for decades. With a reverse mortgage, you can stay in your home and age in place while accessing the equity you’ve amassed over the years. This provides some comfort to seniors who aren’t ready for assisted living or nursing homes and want to stay independent.
• Supplemental income: For seniors who don't have a major nest egg, a reverse mortgage can help them pay for medical care, home repairs and other expenses without taking out a high-interest loan. The money received is typically tax free, too.
• Payment deferral: Unlike traditional loans, payments for a reverse mortgage will not come due unless you pass away or move out of the home.
• Protection against market declines: Most reverse mortgages are non-recourse loans, meaning the borrower or their heirs won't owe more than the home's value when the loan is repaid.

Cons

• High upfront costs: While a reverse mortgage can sound like a perfect solution for a senior, there are significant costs. For instance, a reverse mortgage can come with origination fees, a one-time fee you pay to take out a loan. This can cost up to $6,000. You will also have to pay closing costs, just like if you were selling or refinancing your home. These can include appraisal fees, title searches, formal inspections, surveys and more.
• Interest and fees: There are also several fees that accrue each month. The first is interest charged by the lender. You also have to pay the mortgage insurance premium, which is similar to what you pay when you have less than 20% equity on a home.
• Strict conditions: When you have a reverse mortgage, you are still responsible for staying current with property taxes, homeowners insurance, and maintenance and upkeep. Failure to do so can result in loan default and potential foreclosure.
• Impact on benefits: Funds from a reverse mortgage can affect eligibility for need-based government programs like Medicaid and Supplemental Security Income (SSI).
• Impact on heirs: After you pass away, the reverse mortgage will be paid out of the estate. This often means that the home may have to be sold and the proceeds used to pay back the reverse mortgage. Because reverse mortgages have fees and interest charges, the amount remaining after the home sale may be less than you realize. This will affect how much your beneficiaries receive after your death.

Is a reverse mortgage a good idea?

A reverse mortgage can be appropriate if you’ve looked into any other way to increase your income or decrease your living expenses. It also allows seniors to improve their quality of life without having to sell their beloved home.

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Before taking out a reverse mortgage, you should meet with a reverse mortgage counselor to determine how much it will cost. Knowing what your heirs will be left with can be helpful in making the right decision.