Millions of Americans anticipate a secure and financially independent retirement.
And if they make the right moves earlier in their lives, they can hopefully put themselves in an advantageous position when they finally decide to end their career.
But planning for a successful retirement and getting to enjoy it are two separate things. Sometimes big expenses or cash shortfalls are inevitable.
This is when a reverse mortgage may make sense for some older homeowners.
Reverse mortgages come with unique terms and conditions, as well as risks, so it's crucial for interested homeowners to understand how they work and what to watch out for.
A reverse mortgage is a loan that allows a homeowner who is 62 or older and has considerable home equity to borrow against the value of their home. They can receive funds as:
It is similar to a home equity loan or a home equity line of credit in that it lets you use the value of your current home as security for a new loan, instead of borrowing money to buy a new home (HELOC).
Rather than the homeowner making payments to the lender as is the case with traditional mortgages, the lender makes payments to the homeowner. The homeowner gets to choose how to receive these payments and only pays interest on the proceeds received.
The interest is rolled into the loan balance so that the homeowner doesn’t pay anything upfront.
The loan is paid back when the borrower:
In these cases, the lender takes payment from the home's remaining equity.
When you take out a reverse mortgage, you have six options for receiving the proceeds:
This allows you to get all the proceeds at once when your loan closes. This is the only option that comes with a fixed interest rate out of all available options.
Also called a tenure plan, here the lender makes steady payments to the borrower as long as at least one borrower lives in the home as a principal residence.
Here, the lender gives the borrower equal monthly payments for a set period of the borrower’s choosing, such as 10 years.
Money is available for the homeowner to borrow as needed. The homeowner only pays interest on the amounts borrowed from the credit line.
As long as at least one borrower uses the house as a primary residence, the lender guarantees consistent monthly payments.
If the borrower requires additional funds at any time, the line of credit is accessible.
The lender provides the borrower with equal monthly payments for an agreed-upon time, such as 10 years.
If the borrower requires more funds during or after the term, they can utilize the credit line.
Depending on the sort of loan you choose, the requirements for obtaining a reverse mortgage may vary.
The most common form, however, is the home equity conversion mortgage (HECM), which must meet the following criteria:
You must live in the home full-time, and you must either own it outright or have a lot of equity in it.
The property must also meet Federal Housing Administration (FHA) standards and flood requirements.
It must be either a:
Borrowers must be at least 62 years old.
There are usually no minimum income or credit score requirements, but lenders will look at your credit reports.
Lenders will also usually look at your payment history on:
You'll also need to talk about the reverse mortgage with a HUD-approved HECM counselor.
Borrowers must be able to pay for the home's costs, like property taxes, HOA fees, and homeowners insurance, without using the loan money.
Homeowners must also take care of their homes so they don't fall into disrepair.
Most reverse mortgages let you back out of the deal for any reason up to three business days after the loan closes.
This is called your "right to back out."
After you cancel, the lender has 20 days to give you back any money you've already paid for the loan's financing. If you want to cancel the loan after three days, you should talk to a lawyer to find out if you have the right to do so.
Like with any financial instrument, reverse mortgages have benefits and drawbacks that must be considered before application. Here is something to consider.
Less pressure on your budget: Many seniors lack sufficient income to qualify for or repay loans requiring quick payback, such as home equity loans or home equity lines of credit. A reverse mortgage enables you to get the necessary funds while deferring repayment.
No need to relocate: If you don't want to relocate to access the equity in your house, a reverse mortgage allows you to remain in your home as long as you keep up with property taxes, homeowners insurance, HOA fees, and other costs connected with maintaining the home in excellent shape.
The income isn't taxable: Because the IRS treats the payments as a loan advance, reverse mortgages often provide tax-free income (although you should always consult a tax professional to be sure how taxes apply in your situation).
Loan costs: You must pay for an appraisal, loan origination fees, service fees, and other closing charges throughout the application process. If you still have a primary mortgage, you will still be responsible for property taxes, HOA fees, and insurance.
You could lose your home: The lender may foreclose on the property if you do not pay the needed expenditures and maintain the house, or if you do not reside in the home for 12 months or longer for health-related or other reasons.
Your heirs will need to pay to keep the home: If your loved ones choose to continue living in the property after you pass away, they will need to repay the reverse mortgage or refinance it into a new mortgage loan.
Alternatively, they can sell it and pocket the difference, or if the loan sum is greater than the home's worth, they can hand it over to the lender.
The non-borrower spouse is at risk: If the borrower passes away, the non-borrower will no longer receive payments from the reverse mortgage. If they cannot repay the debt, they might lose their home.
Reverse mortgages are meant for retirees who:
Normally, they are retirees who rely only on a pension or Social Security and have few alternative sources of income. When health care and cost of living expenditures increase, their fixed income may not be sufficient to meet their demands.
If this fits your circumstances, a reverse mortgage might be an excellent option.
But, if you are uncertain about the danger of losing your house if you do not comply with the lender's criteria, you may choose to consider other options, such as:
