We’ve all seen the commercials. Reverse mortgages, they claim, can create a dream retirement, allowing you to live in your home, travel across the globe, ride in luxury cars, and live with no money concerns for the rest of your days!
But is this the truth? Are reverse mortgages really a magic pill for the perfect retirement?
They have their benefits, but you need to fully understand the pros and cons before signing up for this option.
What is a Reverse Mortgage?
To fully understand the benefits and downsides of a reverse mortgage, it helps to take a moment and examine these “mortgages” and understand how they function.
When you purchase a home with a mortgage, a lending institution gives you a large sum of money which you then use to purchase the property. Over 15 to 30 years (in most cases) you repay the loan through small incremental payments. Assuming you pay off the loan, your balance comes to $0.00 and your equity (the percentage you own) becomes 100%.
A reverse mortgage, as the name suggests, works in reverse. An institution makes payments to you and gains equity in the home. Over time, your equity decreases as you receive cash from the institution; essentially, they are buying the home from you in steady payments. (Reverse mortgages can also be a lump sum or a line of credit as well.)
While other types exist, the most common type of reverse mortgage is the Home Equity Conversion Mortgage, or “HECM,” which is an option supported by the FHA.
Pros of a Reverse Mortgage
Better Monthly Cash Flow
The main benefit of securing a reverse mortgage is to increase your monthly cash flow. Essentially, if you own your home completely (or have significant equity), you have a high-value asset that can be converted into cash, which can in turn be used for living expenses, investments, and other options.
Can Stay in Home
Reverse mortgages allow you to utilize equity without moving from your house. Many people have hundreds of thousands of dollars, potentially millions, locked into their homes. They assume that the only way to utilize this value is to sell the house, but a reverse mortgage can provide monthly payments or a lump sum without forcing you from the property.
Pay off the Existing Mortgage
Your current mortgage does not need to be paid off to use a reverse mortgage. You can actually use the proceeds of a reverse mortgage to pay off your existing mortgage, which would improve monthly cash flow by eliminating (or reducing) your mortgage payments.
No Tax Liability
Income is taxed and, generally speaking, the more money you earn the more taxes you’ll have to pay. Payments from a reverse mortgage, however, are not considered income; it’s considered a loan advance. Unlike other retirement payments, such as 401(k) distributions, you will not pay income tax on money from a reverse mortgage. Note: We are not tax experts. Always speak with a tax professional before making any decisions.
Protection for “Underwater” Properties
No, you won’t be protected if your property is literally underwater; you need flood insurance for that! However, sometimes the total amount you owe can be higher than the value of your home, which is referred to as “being underwater.” If this happens, your heirs won’t have to worry about paying the loan balance if the home is under a reverse mortgage.
Cons of a Reverse Mortgage
Like any decision, there are disadvantages. Here are a few of the cons of reverse mortgages…
Equity is Depleted
You have worked hard, lived within your means, and spent decades paying off the mortgage. You now enjoy one of the pillars of prosperity, which is complete ownership of your own home. A reverse mortgage, however, steadily chews away at your equity and could (depending on how it’s structured) completely eliminate your ownership stake. Among a few disadvantages, this means your heirs could have little or no inheritance from your home.
Process Comes with Fees, and Regular Costs Remain
The process of completing a reverse mortgage is not free. You’ll need to work with an expert who can complete the process, so an origination fee and other expenses will be required. You’ll also have to keep up on taxes and insurance to remain in the home. While it can reduce the amount you pay for homeownership, it doesn’t eliminate costs.
Could Impact Government Benefits
Most government benefits will still be available after a reverse mortgage. However, certain needs-based benefits, such as Medicaid and food stamps, could be reduced if you use a reverse mortgage. When calculating your needs, the government will take reverse-mortgage payments into account (which seems inconsistent since it’s officially a loan advancement, not taxed income) which could mean needs-based benefits are reduced.
Can be Complicated
Frankly, reverse mortgages are complicated. They come with rules and caveats, requirements and conditions. You should understand each and every detail before using them, and only sign up for reverse mortgages that you completely and thoroughly understand.
So…Is it Right For You?
To make a final decision on a reverse mortgage, you need to talk with a qualified expert. However, there are a few factors that might help guide your decision.
First of all, if you want to leave a larger inheritance to your heirs, or if you want to leave your property for your family to enjoy after you are gone, a reverse mortgage should not be used. Essentially, the institution creating the reverse mortgage will own it, so you won’t have the property to pass on.
But if you want to stay in your home for the foreseeable future yet need income to help with living expenses, a reverse mortgage could be ideal. They are useful for anyone over the age of 62 (the required age for a HECM) who is struggling with month-to-month budgeting.
Before making any decision, you must speak with a qualified, experienced professional who understands the pros and cons of reverse mortgages and will provide honest, reliable feedback.
Contact our team today if you want more information on reserve mortgages and other options for utilizing your home equity.
