Reverse mortgages are powerful financial tools that should be used by the right people for the right reasons. They offer amazing advantages as well as tricky trade-offs. Weigh all reverse mortgage pros and cons before adding one to your financial plan.
Advantages of Reverse Mortgages
Reverse mortgages bring unique advantages to the table. Here are some of the positives.
Qualifying Is Easy
Because you don't have to make payments, bad credit won't keep you from getting a loan. Reverse mortgages are the only home loan products that don't involve higher interest rates and fees for people with bad credit, and because you don't make monthly payments, low income won't disqualify you either.
Proceeds Are not Taxed as Income
You can increase your cash flow without incurring income taxes. If, for example, you take on a part-time job for extra money, and your tax bracket is 25 percent, you have to earn more than $1,300 to increase your spending money by $1,000. On the other hand, a $1,000 monthly payment from your reverse mortgage actually puts $1,000 in your pocket.
Your Home Still Belongs to You
Some people think that taking out a reverse mortgage means they no longer own their home. That's not true. In fact, if you sell your home, the remaining equity once your loan is repaid comes right back to you. If you stay in your home for the rest of your life, any remaining equity is returned to your heirs. They can also choose to repay the loan and keep the home. If the loan balance exceeds the property value, family members can purchase the home for 95 percent of its appraised value.
A Reverse Mortgage Can Save Your Home
Homeowners who have enough home equity for a reveres loan can use it to get rid of their mortgage, freeing themselves from monthly payments and the risk of foreclosure.
You Can't Outlive Your Loan
If you choose monthly payments for life, you can't outlive your loan. If your balance exceeds your home's value when you move or die, mortgage insurance covers the shortfall.
Reverse Mortgage Proceeds Can Be Used for Anything
Whether you want monthly income to stretch your retirement benefits, a lump sum to get rid of debt or a line of credit in case of emergencies, it's your business. You can even use a reverse mortgage to buy a new home without mortgage payments.
Reverse Mortgage Disadvantages
Reverse mortgages can be great, but they aren't all puppies and rainbows. Here are some reverse mortgage cons.
You Must Live in the Home
Don't take out a reverse mortgage if your plans include a two-year round-the-world excursion – if you're away for more than a few months, you could lose your home to foreclosure -- lenders do periodically verify your address. If you have to rehab an injury for a long time or recover from an illness, going into a nursing facility for an extended stay could cause you problems. If your incapacity lasts more than a year, you can avoid foreclosure by choosing in-home care over a nursing facility.
You Must Maintain the Property or Face Foreclosure
If your home's value is compromised by poor maintenance, the lender could foreclose. If you fail to pay your property taxes or insurance, you could lose your home to foreclosure. Part of your application process includes a financial assessment (credit and income) in which the lender verifies that you can handle those responsibilities. If you don't pass, you can still get your loan, but the lender will withhold some of the proceeds and pay your taxes and insurance for you.
Your Balance Grows Over Time
Home equity loans are much cheaper than reverse mortgages. If you can qualify for one, that's probably a better choice. Reverse mortgages can be expensive because they require mortgage insurance, and because your balance doesn't get smaller over time -- it gets bigger! That means you're paying interest on interest. In addition, you're required to pay for mortgage insurance, and as your balance grows, your mortgage insurance premium does, too.
Reverse Mortgages Can Affect Medicaid or Supplemental Security
If you take your reverse mortgage proceeds as a lump sum, and don't spend it immediately, you could lose eligibility for needs-based programs. In most cases, a single person is only allowed to have $2,000 in cash to be eligible for Medicaid. You can avoid this by structuring your payout properly.
Get Reverse Mortgage Counseling First
You can see that some of these reverse mortgage pros and cons can be difficult to navigate. For this reason, advocates like Consumers Union recommend that you get reverse mortgage counseling (required for government-backed loans), shop carefully for the best reverse mortgage deal, and avoid signing anything that you don't understand.