Should I Use a Reverse Mortgage to Pay Off Debt Before I Retire?
As you consider retirement, securing your financial future is among the most important considerations. Many seniors are eager to pay off remaining debt before they retire, and also fund their lifestyle and prepare for emergencies. For some seniors, a reverse mortgage can help you retire debt-free by unlocking equity in your home. However, using a reverse mortgage to pay off debt may only be a viable option for a small group of seniors who meet specific criteria, and other forms of lending may be better solutions.
Reverse mortgages — which flip traditional home loans on their head, with the homeowner becoming the bank and the lender the borrower — can be highly-effective for some seniors looking to pay off debt before retirement, said John Salter, associate professor of personal financial planning at Texas Tech University and a certified financial planner. “The circumstances are so individualized, but the main purpose is for individuals to have access to money to stay in their homes and make improvements,” he said.
Financial planning experts say the best candidates plan to stay in their homes long-term (ideally 10 years or more) and are not prioritizing leaving their home as part of an inheritance; the loan must be repaid upon home sale or death of the borrower.
“They don’t work very often, but in the right circumstances, they can be a good fit,” said Mark Wilson, a Certified Financial Planner and president of Irvine, Calif., firm Mile Wealth Management LLC. “It is a good thing to have in my toolbox.”
In this post, we’ll talk about using a reverse mortgage to tackle debt.
- How a reverse mortgage works
- Pros and cons of a reverse mortgage
- Other ways to pay off debt before retirement
- Reverse mortgage scams and how to avoid them
How a reverse mortgage works
Unlike a traditional home loan, where a homeowner borrows money and repays it monthly, with a reverse mortgage, the homeowner loans the value of their property to a financial institution in exchange for funds based on the value of the property. There are some limits on the amount of money a homeowner could receive from a reverse mortgage, and the amount varies with interest rates and the age of the borrower. Based on your profile, a qualified lender can help you determine your potential payoff amount.
After recent program changes that took effect in October 2017, HUD now limits borrowers to borrow 58 percent of their home’s equity, as opposed to the 64 percent they were previously able to borrow.
Payments: Reverse mortgages do accrue interest but that interest, plus the principal paid to the homeowner, is only repaid once a property is sold or the homeowner passes away. With a reverse mortgage, the homeowner retains ownership of their home, and they are still required to pay property taxes, retain insurance and maintain the property.
Getting the funds: Reverse mortgage amounts can be paid out monthly or in a lump sum, or established as a line of credit to draw on as-needed. The mortgage amount is based on a combination of factors, including the age of the youngest borrower, the appraised value of the house and current interest rates.
Who’s eligible: To qualify, at least one homeowner must be 62 years old or older, and it needs to be your primary residence.
Where to get a reverse mortgage: The federal government, under the Department of Housing and Urban Development, oversees the bulk of reverse mortgages, known as Federal Housing Authority’s Home Equity Conversion Mortgages, and they are subject to strict rules designed to protect seniors and promote transparency among lenders. To qualify for a government-secured reverse mortgage applicants are required to participate in counseling with a HUD-approved adviser.
Who is a reverse mortgage best for?
This financial equation often works best for people who own their home outright or have just a small amount remaining on their mortgage, experts told LendingTree. That’s because borrowers need to pay off any existing mortgage on the property before you can access the reverse mortgage funds for other purposes. You can use the reverse mortgage to pay off an outstanding mortgage, but if you still owe a large chunk, you wouldn’t have much left over to draw upon. Therefore, the more equity you have in your house, the more value you can unlock with a reverse mortgage. With that reverse mortgage, you can then use your equity to pay off other debts, rather than dipping into other accounts.
“One of the biggest pros is the ability to spend home equity just like you could investment assets, rather than forcing it to be locked up,” said Wade Pfau, professor of retirement funds at the American College for Financial Services.
There are the added costs to consider, too. Along with equity considerations, reverse mortgages can come with hefty upfront costs, possibly upwards of $5000 to cover origination fees, appraisals and closing costs. As such, these costs may not make a reverse mortgage attractive to a senior looking to pay off other debts, since a reverse mortgage comes with its own expenses. In addition, in order to qualify, homeowners must also have sufficient equity in their homes, which may not be available to some seniors with outstanding debt.
According to Wilson, there are two groups of seniors that benefit most from reverse mortgages: Those seeking an established line of credit to draw on as a safety net, or those looking to stay in their homes long-term.
With standby or protective mortgages, as Wilson calls them, credit lines offer seniors flexibility and comfort knowing they can access cash based on their home equity, but without any monthly repayment. “You can transfer the money to any bank account and use it for any purpose,” he said.
With this standby approach, Wilson said seniors should establish the credit line when they are as close to 62 years old as possible, since the amount of money available to borrow loan grows over time as interest accumulates.
With the second group, seniors looking keep their property long-term, Wilson said they want funds to maintain the property and also are comfortable reducing potential inheritance, as the loan is repaid out of the proceeds from a home sale. “These people want to stay in their home and make it work for a long period of time,” Wilson said.
Since reverse mortgages are an unusual financial tool, it is important that borrowers understand they still own the home and need to maintain that property, said Amy Ford, Senior Director of Home Equity Initiatives for the National Council On Aging.
As part of your application, your income, assets, monthly living expenses and credit history will be verified. Seniors should be certain they can afford the upkeep on a home and rising costs, such as any increase in property taxes or insurance. While a reverse mortgage can be used to pay these expenses, Ford says it is imperative that seniors understand the details. For a senior looking to pay off debts before retirement, these property costs could detract from funds available to settle outstanding loans.
“Often people think the bank owns the home and this is an important myth to bust,” Ford said. If someone believes they are no longer the homeowner, “they might think no longer their obligation. That’s been a big pain point, knowing that people understand these obligations and can afford them.”
Pros and cons of a reverse mortgage
For some seniors, a reverse mortgage can be a good financial option to pay off debt. Like any loan, however, it comes with upsides and drawbacks, and the potential to qualify limits the pool of qualified applicants.
The pros of a reverse mortgage:
- A way for seniors to access cash to repay debt, and to remain in their homes after retirement.
- Seniors who own their homes or have a small mortgage can convert that equity into cash or establish a line of credit.
- Can be an alternative to dipping into other income sources, including investment accounts, retirement savings, or equities and securities.
- Rather than monthly or annual payments, the loan and interest on a reverse mortgage is repaid upon death of the borrower or sale of the property.
- Funds can be used for any purpose, including household, health or lifestyle expenses.
- Can be a tool to allow a senior to remain in their home and use equity to repay an outstanding home loan.
- Federal regulations require counseling with a HUD-approved adviser who will walk applicants through the finer points of reverse mortgages.
- Amount that will be repaid can’t exceed market value of home at time loan is repaid.
The cons of a reverse mortgage:
- Since the loan is repaid upon death or sale, the balance is subtracted from sale proceeds, reducing profit for the owner or the inheritance for heirs.
- To qualify, at least one homeowner must be at least 62 years old.
- Borrowers must continue to pay any association fees, property taxes and homeowners’ insurance, and keep up the property.
- If a homeowner has an existing mortgage, the reverse mortgage first goes to pay off that loan before the borrower can tap into funds for other purposes.
- Federally-backed reverse mortgages have a ceiling for the amount of funds (currently $679,650), and a home could be worth more. The amount changes annually, so discuss with your financial adviser.
- Upfront costs can be hefty, often starting at several thousand dollars.
- May not be the best option for homeowners who will not remain in their home for at least five years or longer, as the loan needs to be repaid upon sale, death or after a period of time after moving to an assisted-living facility.
Another potential downside could be psychological and emotional strain, Pfau noted. Many seniors have spent decades faithfully repaying their home loans to reach their goal of home ownership, and a reverse mortgage can feel like a step away from that, he said. Instead, Pfau said homeowners should see the value in their established asset and how a reverse mortgage helps them realize their investment.
“It is a hurdle that some people have to overcome. It can be complicated to understand and people don’t want to take on debt in retirement,” Pfau said.
Recently, HUD imposed new limits and fees on reverse mortgages, which may make them less attractive to some seniors. Initially, applicants must pay a mortgage insurance premium fee of 2 percent of their loan, and during the course of the loan, borrowers will also be charged an annual mortgage insurance premium that equals 0.5% of the remaining loan balance. This is designed to protect the government from defaults on loans.
Other ways to pay off debt before retirement
As part of an overall financial analysis, seniors looking to pay off debt and retiree debt-free may consider alternatives. Since a reverse mortgage is only a suitable choice for a select group of homeowners, financial planners say they have many other choices in their toolbox to assist seniors. These options could work better than a reverse mortgage to pay off debt before retirement, as they preserve your equity in your home and, as such, the proceeds from any eventual home sale.
Home equity line of credit: This is a popular choice for seniors that want to make repairs, upgrades or modifications to their property. By establishing a line of credit, retirees use their home as collateral and only draw out funds when needed. Interest rates are often variable.
“A homeowner may want to get that lined up before retiring because that is a really easy way to access money,” said Bill Houck, a wealth manager for Modera Wealth Management based in Westwood, N.J.
Home equity loan: These lump-sum loans can be a good choice for homeowners needing cash to make improvements or modifications to their homes. Like mortgages, they typically have fixed interest rates, terms and monthly payments.
Refinanced mortgage: With interest rates still historically low, a homeowner with equity in their home and an existing home loan with a higher interest rate could refinance to a lower one. A senior could take a cash-out refinance loan and pay off debts, or refinance with a new loan at a lower rate and use monthly savings to supplement income.
Sell your property and move into a less expensive home: To reduce overhead and expenses, retirees could cash out their homes and move into a smaller property with lower property taxes, less maintenance, and less expensive insurance. Any proceeds from the sale of their home, plus monthly savings, could go to pay off debt and also to fund retirement.
“You could pay off your outstanding mortgage, your car payments and your bills,” said Wilson. “For many seniors, moving to a less expensive place can be an outstanding decision.”
As older Americans consider retirement, a common question from seniors is “Do I have too much debt?” Prior to retirement, consider assessing this by working with a certified financial planner that specializes in retirement, or using online tools to take a comprehensive look at your finances, including your debt and your lifestyle. That’s the best way to determine what financial products – including a reverse mortgage – might be best for you.
Reverse mortgage scams and how to avoid them
With any financial product marketed to retirees, financial advisers say seniors should proceed carefully. While the vast majority of reverse mortgages are government-backed and subject to strict federal oversight, there are some private products that can come with high fees and offer unrealistic promises.
“When people say thinking of retiring and they’re low on funds and they saw something thing on TV for reverse mortgage, usually it doesn’t work at all,” said Wilson. “In most cases, they still have a mortgage on their property and a reverse mortgage isn’t a good fit. It isn’t the pot of money to live off they think.”
To help protect seniors, all lenders who participate in the government programs require applicants to attend counseling with a HUD-approved adviser. In these sessions, advisers explain reverse mortgage programs, including payment options, costs and tax implications. Upon completing the session, borrowers will receive a certificate that is required to advance their application.
There are safeguards in place to identify seniors that may be vulnerable, said Ford. For instance, counselors must ask a list of specific questions to establish financial understanding and applicants must get at least half correct. “Counselors can withhold the certificate if they suspect person isn’t quite grasping concept or some comprehension issues,” Ford said.
In addition to the reverse mortgage counseling, seniors could go a step further and work with a certified financial planner to get a holistic view of their financial position, said Houck.
“You should to hire a professional who is independent from the sales process and independent from the products,” he said. “I think that is the best way to avoid getting sold something that you don’t need.”
Government rules on reverse mortgages have changed in recent years, with more stringent qualifications and regulations. As a result, it is a good idea to inquire with a reputable lender, certified financial planner or a HUD-approved counselor to determine if a reverse mortgage meets your needs and if you’re a viable candidate. As a tool to pay off debt, a reverse mortgage could meet your needs, but there may be other solutions that offer more flexibility and also provide access to cash.