Understanding Reverse Mortgages

Many pre-retirees and retirees consider a reverse mortgage to help supplement their income for monthly expenses. As is the case with every financial decision, it’s important to know exactly what you’re getting from a reverse mortgage, and whether it fits into your financial plan. This blog is intended to provide an overview of this complex topic.  More information can be found through the links provided throughout the post.

What is a Reverse Mortgage?

A reverse mortgage is a loan available to homeowners age 62 or older, who have a low or no mortgage balance. Most reverse mortgages are federally insured, however, there are scammers out there to beware of. Federal law regulates some of the fees that lenders can charge. Also, federal law mandates that prospective borrowers must complete a HUD (Department of Housing and Urban Development)-approved counseling session, which should cover the pros and cons of taking out a reverse mortgage and its impact on your eligibility for government assistance programs such as Medicaid and Supplemental Security Income.  

Reverse mortgages essentially give homeowners the flexibility to turn part of their home’s equity into cash without having to sell or move. In a perfect world, this would help retirees with limited income or savings cover a portion of their monthly expenses using the equity they’ve built up in their home over the years. A reverse mortgage is a loan on which the lender makes monthly payments to the homeowner, and it becomes part of their retirement income stream.

You can take out a reverse mortgage as a lump sum or as monthly payments - whichever works best for your unique financial situation. You could also simply write checks on the reserved loan balance as you need the funds. You’re not obligated to pay the loan back until you move out of the house. If you pass away, your estate pays back your reverse mortgage, generally through the sale of the home, with any remaining equity going to the estate. Note that even if you have a reverse mortgage, you’re still obligated to pay property taxes and insurance, and maintain the home. Failure to do so could result in loss of the home through foreclosure.

What Are the Concerns with a Reverse Mortgage?

Reverse mortgages can be much more expensive than most people realize. You may have to pay a premium on mortgage insurance since you aren’t making regular payments toward your home. You may also have to pay high fees or closing costs associated with your reverse mortgage. 

Reverse mortgages can also be problematic because, unlike a regular mortgage where you are paying down a loan balance and increasing home equity, you are drawing on funds - so the interest on what you owe continues to compound over time. Reverse mortgages also have a negative impact on your net worth in retirement. This could mean less money to leave behind a legacy, and fewer assets to outweigh any other current debts you’re carrying into retirement.

When Do They Make Sense?

Although reverse mortgages have some drawbacks, they can also be beneficial depending on how you leverage them. A few of their benefits are:

  • You don’t have to continue making monthly payments toward your mortgage
  • There aren’t limits on how you use the monthly payment 
  • A surviving spouse can sometimes stay in the home after the borrower passes away, as long as both spouses are listed on the loan

So, when does a reverse mortgage make sense for you? In some cases, the funds from a reverse mortgage can make a colossal impact on someone’s retirement income. 

  • If you don’t currently have a mortgage and are facing hefty expenses - medical or otherwise - a reverse mortgage can help you to manage the expenses while still covering day-to-day living costs
  • If you’re struggling to cover day-to-day living costs in retirement using Social Security and any savings you have, and still want to stay in your home, a reverse mortgage may be a helpful option
  • If most of your net worth is tied up in your home and you need access to the money
  • If leaving an estate to heirs is not important

Reverse Mortgages Through HUD

Although there are several reverse mortgage programs, a popular loan is the HUD FHA Reverse Mortgage for Seniors (HECM). Under the HUD program, mortgage insurance is typically the most expensive part of the reverse mortgage loan (including any applicable fees) - and is capped at 2% of the loan balance. If you’re considering a HECM, the amount that is available through a reverse mortgage loan is dependent on:

  • Age of the youngest borrower (or eligible non-borrowing spouse)
  • Current interest rate
  • Lesser of appraised value or the HECM FHA mortgage limit (or the sales price)
  • The homeowner going through the mandatory counseling 

What You Need to Know

If you’re wondering whether a reverse mortgage is right for you, there are a few things you need to keep in mind. First and foremost, your reverse mortgage won’t provide 100% of your home’s value. In most cases, it’s capped at approximately 80%, with the maximum dollar amount as $726,525 in 2019. 

You can receive funds as a single lump sum, or you can request them as monthly installments or as a line of credit. Funds aren’t taxed, because they aren’t viewed as regular income. It is very important to understand the terms, conditions, and fees associated with a reverse mortgage before embarking on this route.

Get Help

Before you commit to a reverse mortgage, talk to a professional! A fee-only financial planner can help you evaluate what choice is best for you, and how to help reduce your monthly expenses (or increase income) if you’re concerned that a reverse mortgage may not be the best solution.

Wood Smith Advisors, a woman-owned Registered Investment Advisor (RIA), is a fee-only financial services firm that partners with its clients to simplify their financial lives. We focus on women, entrepreneurs, and individuals with complex financial situations, providing objective and competent advice, education and services to help them develop and build their businesses and reach their financial goals. We can be reached by clicking here.

"Finance Made Simple" blog posts are intended for educational purposes and not for specific advice. Each person’s situation is different. Consult your financial advisor for advice relating to topics discussed.

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