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Reverse Mortgage Pros and Cons
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A reverse mortgage is a home loan that allows homeowners ages 62 and older to tap their home equity and receive payments from their lender. Unlike a forward mortgage where you make payments to your lender every month, a reverse loan pays you — so long as you keep paying your property taxes and homeowners insurance premiums, and maintain your home.
With so much reverse mortgage information advertised online and on TV, it’s important to understand reverse mortgage pros and cons before signing on the dotted line.
What is a reverse mortgage?
A reverse mortgage is a special type of home loan that allows older homeowners with significant equity to borrow against their home’s value without having to make a monthly payment.
With a standard home loan (also called a “forward” mortgage), your loan balance is reduced with each monthly payment and your equity increases. The opposite happens with a reverse mortgage, because your loan balance grows and your equity shrinks.
Although some lenders offer their own reverse mortgage products, most reverse mortgages are issued as Home Equity Conversion Mortgages, or HECMs. HECMs are the only reverse mortgage insured by the Federal Housing Administration (FHA). For the purposes of this article, we’ll cover HECM borrowing guidelines and loan features.
Reverse mortgage pros and cons
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 reverse mortgage funds as monthly income, you’ll have a reliable flow of monthly cash in your budget.
You can pay off debt. If you have unpaid medical bills or high-interest debt, you can pay it off 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 more flexibility. 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 income, so they aren’t taxable — regardless of whether you receive them as a lump sum, monthly income, a 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 pass away.
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 continue paying your property taxes, homeowners insurance and homeowners association (HOA) fees on time.
Your spouse can stay in the home after you pass away or move out. Even if your spouse wasn’t a co-borrower on the loan, he or she 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 HUD.
Your home’s equity will shrink. A big downside to reverse mortgages is the loss of home equity. Because you’re not paying down the balance of a reverse mortgage, 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 and upfront mortgage insurance premiums of 2% of the home’s value, reverse mortgage costs are more expensive than other types of home loans.
You may be disqualified from other income benefits. Consult with a financial planner 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 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. 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 healthcare 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 for most of the year 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 reverse mortgages work
Reverse mortgages are similar to regular mortgages in some ways but very different in others.
How reverse mortgages are the same
- 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 homeowners association (HOA) fees
- You need to maintain your home
How reverse mortgages are different
- You can receive your funds as a line of credit or as a lump sum
- You can receive the funds as monthly income
- You don’t make any payments until you leave the home or pass away
- Your equity decreases for as long as you have the loan
Reverse mortgage requirements
A number of factors determine who qualifies for a reverse mortgage. The rules for reverse mortgages require that you:
- Are 62 years or older
- Own the home outright or have significant equity (at least 50%)
- Finance a home that you live in for most of the year
- Are not delinquent on federal debt like income taxes or student loans
- Set up an account to pay ongoing property taxes and homeowners insurance
- Keep the home in good condition
- Get counseling from a HUD-approved reverse mortgage counseling agency