Reverse Mortgage Pros and Cons
A reverse mortgage is a special type of home loan that allows older homeowners with significant equity — at least 50% — to borrow against their home’s value without making any monthly payments. Unlike a traditional (“forward”) mortgage where you pay the lender, when you take out a reverse mortgage, the lender pays you — but is it too good to be true?
We’ll go in depth on reverse mortgage pros and cons and help you figure out if a reverse mortgage is right for you.
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Pros and cons of a reverse mortgage
You may be wondering if a reverse mortgage is a good idea or, due to recent mortgage industry scams, you could be worried that they’re just a ripoff. Reverse mortgages are a legitimate financial product, but that doesn’t mean they’re right for everyone.
There are several reverse mortgage types; here, we’ll focus on the home equity conversion mortgage (HECM) program, which is backed by the Federal Housing Administration (FHA). We’ve listed out the main advantages and disadvantages of reverse mortgages below to help you determine whether this loan type could work for you:
Pros: The perks of a reverse mortgage
You can stay in your home longer. The flexible options for tapping equity give you more ways to meet changing financial needs as you get older. For example, making home improvements to age in place with a reverse mortgage may be more affordable than selling and downsizing your home.
You can add to your retirement income. If you choose to receive payouts from your reverse mortgage on a monthly basis, you’ll have a reliable flow of cash in your budget.
You can pay off debt. If you have unpaid medical bills or high-interest debt, you can pay off your balances with a lump-sum distribution.
You can leave other retirement accounts alone. Drawing income from a reverse mortgage may help you avoid early withdrawal penalties from other accounts in your retirement portfolio.
You’ll have more financial freedom. You can use reverse loan funds however you’d like, giving you the flexibility to do what’s important to you and your family. You can help a child out with college tuition or renovate your home to meet special needs as you or a loved one ages.
Your reverse income is not taxed. The IRS doesn’t consider reverse mortgage payments as income, so they aren’t taxable — regardless of whether you receive them as a lump sum, monthly income, line of credit or any combination of the three.
You won’t leave an underwater home to your heirs. Reverse loans have built-in protections that limit your heirs’ responsibility for any remaining balance after you die.
You don’t have to meet debt-to-income (DTI) ratio requirements. No mortgage payment means less income is needed to qualify. However, a lender will need to verify that you can maintain your property taxes, homeowners insurance and, if applicable, homeowners association (HOA) payments.
Your spouse can stay in the home after you die or move out. Even if your spouse wasn’t a co-borrower on the loan, they can stay in the home after you die or move into a long-term care facility — if you were married at the time you took out the reverse mortgage. However, they must meet certain conditions set by the U.S. Department of Housing and Urban Development (HUD).
Cons: The downsides of a reverse mortgage
Your home’s equity will shrink. A big downside to reverse mortgages is the loss of home equity. Because you’re not paying down your reverse mortgage balance, you’ll make less profit when you sell, or limit your borrowing power if you need a new loan.
You’ll pay high upfront fees. With loan origination fees up to $6,000, upfront mortgage insurance premiums worth 2% of your home’s value and other closing costs, reverse mortgages are more expensive than other home loan types.
You may be disqualified from other income benefits. Consult with a financial planner or attorney before you decide how to receive your funds. Why? Your eligibility for Supplemental Security Income (SSI) or Medicaid may be impacted if you receive reverse loan funds.
You’ll reduce your heirs’ inheritance. As a reverse mortgage balance grows, the equity your heirs would receive is diminished. If they can’t repay the loan when you pass away or move, they won’t be able to keep the home.
You might lose your home to foreclosure. You’re still responsible for paying property taxes and insurance, and if you default on your property taxes, you could lose your home to tax foreclosure. A reverse mortgage lender can foreclose on the home if you’re not living in it for more than 12 consecutive months due to health care issues.
You can’t use a reverse loan for investment or vacation homes. You must prove you’re living in the home that you’re financing to qualify for a reverse mortgage.
You won’t get a tax benefit while the loan is in place. The interest on a reverse mortgage isn’t tax-deductible until all or part of the balance is repaid.
How much money do you get from a reverse mortgage?
The amount of money you’re able to borrow depends on the exact reverse mortgage product you choose, the lender and an analysis of your situation, including your age and home’s value. The absolute maximum you can qualify for with a HECM loan — the only federally backed reverse mortgage loan type — is $970,800 in 2022.
You can use LendingTree’s reverse mortgage calculator to estimate how big of a lump sum you will likely qualify for; for other payout types, which require more complex calculations, you should contact a lender or housing counselor.
Reverse mortgage requirements
As with all mortgages, a number of factors determine who qualifies and with what loan terms. However, unlike traditional forward mortgages, reverse mortgages don’t have minimum requirements set for credit score and income. However, there are still requirements for the following:
- Age. You must be at least 62 years old. But although many people think of a reverse mortgage as a way for people to bridge the gap between age 62 and 66 (full retirement age), if you wait until age 66 you’ll be able to get a higher payout.
- Home equity. You must own the home outright or have significant equity (at least 50%).
- Residence. The home must be your primary residence.
- Federal debt history. Delinquent federal debt, like income taxes or student loans, can make you ineligible for a reverse mortgage.
- Property upkeep. You must continue to keep the home in good condition.
- Housing counseling. You’re required to undergo counseling with a HUD-approved reverse mortgage counselor.
- Taxes and insurance. It’s crucial to stay on top of your ongoing property taxes and homeowners insurance — otherwise you could lose your house to a property-tax lien foreclosure.
Reverse mortgages vs. traditional mortgages
Here’s a quick rundown of the ways in which reverse mortgages are both similar to and very different from traditional mortgages:
How reverse mortgages are the same as traditional mortgages
→ Your loan is secured by your home
→ Your new mortgage pays off any existing home loan you have
→ You must continue paying property taxes, homeowners insurance premiums and HOA fees
→ You’ll need to maintain your home
→ Fixed and variable interest rates are available
How reverse mortgages are different from traditional mortgages
→ You can receive your funds as one lump sum, as monthly payouts or as a line of credit
→ You don’t make any payments until you leave the home or die
→ Your equity decreases for as long as you have the loan
Who is a reverse mortgage right for?
Here are a few rules of thumb that can help you evaluate whether a reverse mortgage makes sense in your situation.
A reverse mortgage may be a good idea if:
- You and your spouse are both 62 or older
- You’re in good financial standing
- You and your spouse are physically able to maintain the home
- You’ve considered the needs of your heirs
- You’ve built enough equity that you have a low mortgage balance and the payout from a reverse mortgage would cover your needs
- Your home value is or has been increasing
A reverse mortgage is likely a bad idea if:
- Your home has sentimental value and either you or your family feel strongly that it should stay in the family when you die.
- You live with others who couldn’t easily move if you became disabled
- Your health is shaky or unpredictable
- You’re planning to move soon
- You need more than FHA loan limits allow ($970,800 in 2022)
Alternatives to a reverse mortgage
If you want to borrow against your home equity, don’t be fooled into thinking that a reverse mortgage is your only option. In fact, in recent years, reverse mortgages were sometimes the least popular method homeowners used to draw against their home equity. Instead, they’d opted in greater numbers for home equity lines of credit (HELOCs), cash-out refinances and home equity loans — still, each of these loans has its own requirements, loan limits and monthly costs to consider.
Below is a quick snapshot of how these loan types stack up against a reverse mortgage, but you can also consult our fuller comparison between reverse mortgages, home equity loans and HELOCs for more details.
Reverse mortgage vs. home equity loan
A home equity loan — also known as a “second mortgage” — is a loan of up to 85% of your home equity that you receive as a lump sum, and pay back in fixed installments at a fixed rate. It’s more difficult to qualify for a home equity loan than a reverse mortgage, as it requires income and credit qualification. Home equity loan requirements demand a minimum 620 credit score and at least 15% in home equity.
Reverse mortgage vs. HELOC
A HELOC is another type of second mortgage — though in this case, instead of paying out a lump sum, it operates more like a credit card secured by your home. You can draw on your credit line whenever you want within the “draw period” — a set term during which you only have to make interest payments — which usually lasts 10 years. Like home equity loans, they have income, credit and other requirements, which makes them less accessible to borrowers with low income or bad credit than reverse mortgages.
Reverse mortgage vs. cash-out refinance
A cash-out refinance is when you take out a new home loan for more than what you owe on your existing home loan — you do this so that you can pocket the difference in cash. One advantage to a cash-out refinance is that you’ll build equity over your loan term rather than continuously shrinking it as you would with a reverse mortgage.
A jumbo reverse mortgage is a loan from a private lender for more money than is allowed by the “maximum claim amount” set by the FHA for their HECM program. In 2022, this amount is $970,800.
Yes, you can refinance a reverse mortgage and there are many reasons borrowers may want to — among them, getting a better interest rate, adding a spouse to the loan or helping the heirs of a deceased homeowner keep the home.
While the homeowner is alive and living in the home, lenders don’t require them to make monthly — or any — payments on the reverse mortgage loan. But, as soon as the homeowner dies, the entire loan balance will be due. Surviving family members often sell the home to pay this loan off, but if they want to keep it, they have the option of paying off the loan balance in cash. If they aren’t able to access enough money to pay the entire loan balance, they may also refinance the existing reverse mortgage.
Although reverse mortgages are a legitimate financial product, reverse mortgage scams are also a very real phenomenon you should be aware of. The Consumer Financial Protection Bureau (CFPB) recently fined American Advisors Group — the company whose commercials prominently feature actor Tom Selleck — $1.1 million for using deceptive marketing tactics.
The good news is that most reverse mortgages give you the right to change your mind without having to pay any penalties. As long as you take the proper steps to cancel the transaction within three business days of closing, the lender is required to refund any money you put toward obtaining the loan.