Reverse mortgages give senior homeowners a way to tap into the equity of their property without having to sell or move. Before making this decision, it is important to fully understand both the potential benefits and the risks involved.

What Is a Reverse Mortgage?

A reverse mortgage is a type of loan available to homeowners aged 62 or older that allows them to convert part of their home’s equity into cash without selling the property. Unlike traditional mortgages, borrowers are not required to make monthly repayments. Instead, the loan is repaid when the home is sold, the borrower permanently moves to a care facility, or the homeowner passes away. Many retirees turn to reverse mortgages to help cover living expenses, medical costs, or other needs during retirement. However, while they can improve cash flow, reverse mortgages also involve significant expenses and potential downsides, including reduced home equity and possible impacts on the inheritance left to family members.

How Reverse Mortgages Work

When you take out a reverse mortgage, the lender converts a portion of your home’s equity into loan proceeds. You can choose to receive these funds as a lump sum, in regular monthly installments, or through a line of credit that can be accessed when needed. The proceeds are not considered taxable income, and repayment is deferred until you sell your home, move out permanently, or pass away. The amount you can borrow depends on the home’s current appraised value, your age at the time of application, and the prevailing interest rates. In the United States, the most common program is the Home Equity Conversion Mortgage (HECM), which is federally insured through the Federal Housing Administration (FHA).

Types of Reverse Mortgages

There are two primary categories of reverse mortgages in the U.S., each with specific features and requirements:

• Home Equity Conversion Mortgage (HECM): The most common reverse mortgage, insured by the federal government and available through FHA-approved lenders.

• Proprietary Reverse Mortgages: Privately funded loans that are often used for higher-value homes, allowing homeowners to access larger amounts of equity than is permitted under the HECM program.

Borrowers also have flexibility in how they receive the funds:

• Lump Sum: A single payment made at closing.

• Monthly Payments: Fixed regular payments for a set number of years or for as long as you remain in the home.

• Line of Credit: A flexible option allowing withdrawals when needed, similar to a home equity line of credit (HELOC).

Reverse Mortgage Pros and Cons

Advantages:

1. No Monthly Repayments: The loan is only settled when the property is sold or vacated.

2. Access to Home Equity: Provides a way for retirees to supplement their income without having to sell their home.

3. Tax-Free Proceeds: The money received from a reverse mortgage is not taxed.

4. Multiple Payment Options: Borrowers can select the payout method that suits their financial needs.

Disadvantages:

1. Higher Fees and Interest: Costs are often greater than those of conventional mortgage products.

2. Erosion of Equity: As interest accumulates, the remaining equity in your home declines over time.

3. Potential Impact on Inheritance: If the loan balance exceeds the property’s market value, heirs may inherit little or nothing.

4. Eligibility Criteria: Applicants must meet the minimum age requirement and the home must meet lender and program standards.

Reverse Mortgage Fees

Reverse mortgages often involve several types of costs, which can make them more expensive than other borrowing options:

• Origination Fees: Charged for processing and setting up the loan; amounts vary by lender.

• Interest Rates: Usually higher than those for traditional mortgages due to the deferred repayment schedule.

• Mortgage Insurance Premiums: Often required to protect the lender if the loan balance exceeds the home’s value.

• Closing Costs: Expenses such as property appraisals, legal services, and title insurance.

How Much Can You Borrow?

Several factors determine the loan amount:

1. Home Value: Higher-valued properties typically allow larger borrowing limits.

2. Age of the Borrower: Older homeowners can often access a greater percentage of equity.

3. Current Interest Rates: Higher rates reduce the maximum loan amount, as they increase the projected loan balance over time.

4. Available Equity: The more equity you have, the more funds you can qualify for.

Generally, borrowers may be able to access between 30% and 55% of their home’s appraised value.

Common Issues and Risks

Despite their benefits, reverse mortgages carry notable risks:

• Rising Debt Over Time: Without monthly repayments, interest is continually added to the balance.

• Possible Effects on Benefits: Receiving reverse mortgage funds may affect eligibility for needs-based programs such as Medicaid or Supplemental Security Income (SSI).

• Foreclosure Risk: If you fail to meet requirements such as paying property taxes, keeping up homeowners insurance, or maintaining the property, the lender can foreclose.

Alternatives to Reverse Mortgages

Before committing, consider other ways to access cash or reduce expenses:

• Home Equity Line of Credit (HELOC): If you qualify and do not meet the reverse mortgage age threshold, a HELOC may offer lower rates and more flexible repayment.

• Selling or Downsizing: Selling your home and moving to a smaller or less expensive property can free up equity without taking on debt.

• Government Assistance: Explore federal, state, or local programs designed to support seniors financially.

Frequently Asked Questions

Q: Can I lose my home with a reverse mortgage?
A: Yes. Failure to meet loan obligations such as paying property taxes or maintaining insurance can result in foreclosure.

Q: Is the money from a reverse mortgage taxable?
A: No. The funds are considered loan proceeds, not taxable income.

Q: How can I know if this option is right for me?
A: Consult a qualified financial advisor who can review your personal situation and long-term goals.

Sources

Home Equity Bank

Bankrate

Financial Consumer Agency of Canada