Reverse Mortgages: A Retiree’s Friend or Foe?
If you are one of the millions gearing up for retirement, it is likely you’ve considered more than one financial strategy to ensure your money lasts throughout a long, comfortable post-work life. Many retirement tactics focus on generating a guaranteed income stream to supplement other income sources, like a pension, social security, or retirement account distributions. A reverse mortgage is one of these vehicles as it has the ability to create positive cash flow for retired or soon-to-be retired homeowners. But a reverse mortgage gets a lot of attention from both advocates and skeptics making it a challenge to know if the vehicle is a good fit.
First, let’s break down what a reverse mortgage is, and then we’ll dive into advantages and drawbacks to consider before making this part of your overall retirement picture.
What, Exactly, is a Reverse Mortgage?
The need for the right mix of retirement strategy is necessary given nearly one-quarter of baby boomers have little to no savings set aside for this important objective. Combine the savings gap with rising costs for healthcare and longer lifespans and many retirees are in need of a financial lifesaver. In some cases, home equity is an overlooked asset that, in the right circumstances, can be tapped to help make up a retirement savings shortfall.
Enter the reverse mortgage.
Sometimes referred to as a home equity conversion mortgage (HECM), the most common type of a reverse mortgage is a loan insured by the Federal Housing Administration that gives certain homeowners at or near retirement age access to a portion of their home’s equity. Proceeds from a reverse mortgage can be taken as a lump sum or as a monthly income stream, giving retirees access to equity in the way they see most fit for their circumstances. And, a reverse mortgage does not require repayment so long as the home remains the primary residence and is not sold. Once the home is sold or the homeowner passes away, the property is either sold or refinanced by the heirs, or sold by the lender to recover the amount of the reverse mortgage loan.
Not everyone qualifies for a reverse mortgage, however. Homeowners are eligible when:
- The youngest borrower on the title is at least 62 years old
- The home is the primary residence
- The home has equity
- Any current mortgage balance can be paid off with proceeds from the reverse mortgage
- The property is a single-family, townhouse, approved condominium, or manufactured home
- The homeowner meets financial eligibility requirements laid out by HUD
To qualify for a reverse mortgage that falls under the category of HECM, homeowners must also complete a HUD-approved counseling session, maintain the home over time according to FHA guidelines, and continue to pay homeowners insurance and property taxes. There are non-HECM reverse mortgage loans available as well, although they are not insured by the federal government and may come with higher costs.
Benefits of Reverse Mortgages
Reverse mortgages come with a myriad of benefits, not the least of which is the ability to access your home’s equity in an affordable way. As a retired homeowner who qualifies for a reverse mortgage, you also have the opportunity to use the proceeds for various needs, like paying off an existing mortgage balance, covering medical bills, credit card debts, or vehicle loans, or managing necessary home repairs and renovations. Most importantly, a reverse mortgage gives you the option of taking a lump sum of cash, creating an income stream, or establishing a credit line from your home’s equity. This flexibility is beneficial in keeping up with life’s expenses, planned or unexpected, throughout a long retirement.
Above and beyond the access to cash from your home’s equity, a reverse mortgage also offers some advantages that are less apparent. First, you remain in your home and keep the title in your name, giving you control over transferring the property to heirs upon your passing. In fact, anyone who inherits a home with a HECM loan still receives remaining equity once the loan balance is paid. Also, reverse mortgage loan proceeds are not taxable as income, and there is no need to make monthly payments on the loan as there would be with a home equity loan or line of credit.
Reverse Mortgage Risks
While there are several upsides to getting a reverse mortgage, this retirement planning strategy is not without risks. First and foremost, approval for a reverse mortgage requires the lender be the only lien on the property. This means that your proceeds from a reverse mortgage must be enough to pay off any existing mortgage balance; the remaining equity is provided as income, a lump sum, or credit line access. Additionally, a reverse mortgage still requires you to cover home expenses, including ongoing maintenance, property taxes, and homeowners insurance. These costs are not wrapped up in the reverse mortgage like they are with a conventional purchase or refinance loan. Failing to stay current on these expenses may put you in default, which could ultimately lead to foreclosure.
It is also important to recognize that reverse mortgages are not without their own costs, including interest and lender fees. These expenses must be repaid when the home is sold or refinanced, whether that is by the homeowner due to a move, or heirs when the property is inherited. Also, you are only allowed to live outside the home for a total of 12 months. This means that if you experience a need for long-term care out of the home, or decide to go on an extended vacation, you will need to speak with your reverse mortgage lender beforehand to ensure you aren’t voiding your agreement.
The Bottom Line
A reverse mortgage may be a viable retirement planning vehicle for many retirees with equity in their primary residence. This strategy offers flexibility in terms of access to cash while allowing you to maintain ownership of the home. However, you must be aware of the risk factors in reverse mortgages and how they may impact your ability to move or pass property on to others in a cost-effective way. Be sure to speak with your lender at length about these advantages and drawbacks before determining a reverse mortgage is the best choice for you in retirement.