We are continuing our series on retirement income. One method that is often discussed, and draws really strong opinions, is getting a reverse mortgage. While reverse mortgages can be helpful, they can also be risky. Before you decide to get a reverse mortgage, it is important to understand exactly what you are getting into and how it can affect your financial future.
What Is a Reverse Mortgage
Reverse mortgages are essentially a type of cash-out refinancing, allowing you to turn your real estate equity into cash. This equity is determined by taking the value of your home minus the amount you still owe on your home (if any).
Many homeowners typically own their own home outrightly or have just a small amount remaining on an existing mortgage, giving them plenty of equity to cash in with a reverse mortgage. The cash received via a reverse mortgage can then be used for anything from remodeling, going on vacation, covering living expenses, etc. This is why it is commonly used to supplement one’s income in retirement.
However, there are eligibility requirements that must be met for a reverse mortgage.
For starters, you must be 62 years or older in order to qualify. Additionally, reverse mortgages are only available for your primary residence and must remain your primary residence for the length of the reverse mortgage.
To be considered your primary residence you must live at the property for 6 months or more every year. Lastly, you should have a significant amount of equity (50% or more) in your home to qualify for a reverse mortgage.
How A Reverse Mortgage Works
Unlike a traditional mortgage where the bank gives you money for purchasing a house, a reverse mortgage is where the lender simply gives you cash for the equity in your home. The amount of your reverse mortgage is determined based on your age, the equity you hold in your home, and how much you still owe on a traditional mortgage.
After your reverse mortgage is approved, there are three different ways to structure your payment from the lender.
One method is to simply receive the entire amount in a single lump sum payment.
Another option is to establish monthly payments of a particular amount for a predetermined number of years.
Lastly, you can opt to use it as a line of credit, getting the amount of cash you need when you need it.
Please note: both the monthly payment options and the line of credit option can be combined together. If you choose to receive all of the lump sum at once, then there wouldn’t be a line of credit option.
Another key difference with reverse mortgages is that there are no monthly payments. Instead, the loan is repaid in a lump sum when you die, move out permanently, or you or your heirs sell the home. Oftentimes a reverse mortgage is repaid by the proceeds from the sale of your home.
Note that reverse mortgages are a non-recourse loan, meaning the maximum amount that will need to be paid to the lender is the fair market value of the home, even if housing prices fall and your home sells for less than the balance of the reverse mortgage. In other words, you (or your estate) isn’t on the hook if the real estate market crashes after you get your reverse mortgage and your home isn’t worth as much as your loan amount.
On the other hand, though, if there is equity remaining after repaying fair market value, it goes to your estate. So there is a possibility that your beneficiaries will receive something from the home, even if you do take out a reverse mortgage on it.
Benefits of a Reverse Mortgage
Reverse mortgages are a useful financial tool, especially when you find yourself in need of funds in retirement. One of the biggest benefits of a reverse mortgage is that it puts cash in your pocket when you need it. This can be helpful in covering day-to-day living expenses as well as financing the trip you’ve been putting off or simply completing the necessary remodels to make your home easier to live in as you age, which is something really important that I’ve talked about before in our series on long term care.
Another benefit of reverse mortgages is that there are no monthly payments. This can actually increase the amount of available funds you have every month since you no longer have to pay on a traditional mortgage. All the while you can remain in your home for as long as you want or are able to.
It can also be seen as a “last resort” type of tool that can help you fund end of life expenses. Maybe your investments are drawn down completely later in retirement, and you need something to help with living expenses. Or perhaps you need to pay for long term care expenses, and you can use your home equity via a reverse mortgage to help you do that.
Drawbacks of a Reverse Mortgage
There are clearly some benefits to getting a reverse mortgage. However, there are several drawbacks that must be considered.
While a reverse mortgage may seem like “free” money, they essentially exist for lenders to make money. Lenders make this money through the fees added to the total balance of the loan, which are typically quite high. These fees include origination or start up fees, accruing monthly account maintenance fees, and compounding interest fees. Also, note that reverse mortgages typically have higher interest rates than conventional mortgages.
In addition to these fees, another drawback of obtaining a reverse mortgage is that there is often a long list of requirements for you to be in good standing with the company offering the reverse mortgage. This includes being required to purchase a mortgage insurance policy to protect the lender against the mortgage.
Additionally, you’ll still be on the hook for property taxes, maintenance of the home, utilities, HOA fees, and other home costs. If you fall behind or fail to pay these extra expenses, the lender could foreclose on your home.
Is A Reverse Mortgage Right For You?
This is a tough question and I can’t give you an answer through this blog. I can say that I typically don’t love reverse mortgages. But, there are times when they can be helpful. I have known people who have needed them and used them as a last resort. These were people who had depleted all of their other assets and investments and the last place they had to turn was the equity in their home. And frankly, it worked out for them (despite the high fees and other restrictions).
That’s how I personally view them (as a last resort), and I wouldn’t consider them an ongoing source of income in retirement.
I would also be quite nervous if you needed to use a reverse mortgage too early in life, especially in your 60s or even your 70s. Why? Because to me, that would mean that you’ve depleted or are close to draining your other retirement assets, leaving the equity in your home as your only remaining asset.
If you’re considering getting a reverse mortgage this early in life, I’d encourage you to instead think about some kind of part-time work, at least temporarily, while you are still young enough and able to work. I know it may not be ideal, but it’d allow you to save more money for later on in life when you aren’t able to earn an income any longer. This would delay the need to take a reverse mortgage, which again I view as more of a last resort than anything else.
Okay, that has been quite a lot, so thank you for staying with me. If you’d like to learn more about everything you need to do to retire, check out my free books on retirement planning, available at freeretirementbooks.com. Have a great week!