A reverse mortgage is a type of home loan that allows homeowners who qualify to convert a portion of the equity in their homes to cash. Most reverse mortgages allow borrowers to use the loan proceeds for any purpose. Homeowners often choose to use the proceeds from a reverse mortgage to:
- Supplement social security and/or retirement income;
- Pay medical bills not covered by insurance; or
- Make home improvements.
Some reverse mortgages can even be used to purchase a primary residence, as long as the borrower has enough cash to make up the difference between the loan proceeds and the sales price plus closing costs.
Who Qualifies for a Reverse Mortgage?
Reverse mortgages are only available to homeowners who are 62 years of age or older. Borrowers must own their homes outright or owe very little on their existing mortgages. If there is an existing mortgage, a portion of the reverse mortgage proceeds must be used to pay off that mortgage. The property securing the reverse mortgage must be the borrower’s primary residence.
Benefits of Reverse Mortgages
One of the biggest advantages of a reverse mortgage is that the borrower does not have to make any monthly mortgage payments during the life of the loan. For many seniors, this fact alone makes a reverse mortgage more attractive than other types of loans, such as a home equity line of credit or a second mortgage. In fact, reverse mortgages don’t need to be repaid until the borrower does one of the following:
- Dies
- Moves to a different primary residence, or
- Defaults (for example, fails to maintain homeowners insurance on the property, pay property taxes, or make necessary repairs).
Another benefit of reverse mortgages is that they are non-recourse loans. This means that if the borrower defaults, the lender may foreclose on the borrower’s home but cannot pursue any collection efforts (including seeking a deficiency judgment) against the borrower.
Other benefits of reverse mortgages include the following:
- Because monthly mortgage payments are not required, many reverse mortgages have no income requirements.
- The proceeds of a reverse mortgage are generally not taxable.
- You may be able to choose to receive the proceeds of your reverse mortgage as a lump sum, line of credit, or monthly cash advance.
Disadvantages of Reverse Mortgages
One of the biggest disadvantages of a reverse mortgage is that the borrower’s heirs must pay off the loan when the borrower dies. If the heirs don’t care about keeping the home, they can sell the home and give the proceeds of the sale to the lender. Because the loan is non-recourse, if the house sells for fair market value but less than the amount of the outstanding debt, the lender has to absorb the loss. But if the heirs want to keep the home, they will have to repay the loan in full, even if the amount of the loan is greater than the value of the home.
Other disadvantages of reverse mortgages include the following:
- Most reverse mortgages have an adjustable rate, which means that the interest rate may go up.
- Interest on a reverse mortgage is not tax deductible until the loan is repaid.
- Reverse mortgages are typically more expensive than other types of home loans. There can be significant upfront fees (origination fees, mortgage insurance premiums, and closing costs), as well as ongoing servicing fees during the term of the mortgage.
- The amount owed under a reverse mortgage grows over time. Because the borrower never makes any monthly payments on a reverse mortgage, any loan funds that are advanced or interest that is charged is added to the amount of the outstanding debt.
Be a Savvy Borrower
Additional information on reverse mortgages can be found on the Department of Housing and Urban Development’s website page on Home Equity Conversion Mortgages for Seniors and the AARP’s page on Reverse Mortgages. Before taking out a reverse mortgage on your home, you may also want to consult with a trusted financial advisor or real estate attorney.
