Pros and Cons of Tapping into Your Home Equity with a Reverse Mortgage

After decades of faithfully paying their mortgage, many retirees find themselves in a position in which they have significant equity in their homes, but cash flow is tight due to low retirement income and/or savings.  Looking for a source of funds to pay for daily living expenses or perhaps increased medical bills, some turn to the idea of reverse mortgages, thinking that trading some of the equity in their home for a lump sum or an income stream over a number of years could be the answer to their problems.  Unfortunately, in some cases, this tactic generates more problems for the borrower, their spouse, and/or their heirs down the road.  Before entering into a reverse mortgage agreement, you must make sure that you understand the terms and features of your particular agreement and that you consider carefully the pros and cons, as discussed below.

Features of Reverse Mortgages:

• Borrower must be age 62 or older and must have either no mortgage or a low enough mortgage balance that it can be paid off with loan proceeds.
• Equity in your home is traded in exchange for payments received monthly, as a lump sum, or as needed through a line of credit.
• The loan usually does not have to be repaid until you die, sell your home, or move out.
• There are three three types of reverse mortgages:  single-purpose (government agencies or nonprofits are the lenders, funds must be used for one purpose such as home repairs or property taxes); proprietary (private companies are the lenders, funds can be used for any purpose); or Home Equity Conversion Mortgages, HECMs (U.S. Department of Housing and Urban Development is the lender, funds can be used for any purpose).  A subset of HECM loans, called HECM for Purchase, allow retirees to buy a new home using a reverse mortgage.

Pros:

• Reverse mortgages are a source of income that still allows you to stay in your home, and loan proceeds are generally tax-free.
• Income from reverse mortgages generally does not impact your Social Security or Medicare payments.
• Most reverse mortgages include a “non-recourse” clause, so that you or your estate cannot owe the lender more than the appraised value of the home when the loan comes due, even if the accrued interest and fees exceeded that amount.

Cons:

• As a borrower, you will pay significant upfront costs due to the mortgage origination fee, mortgage insurance, and closing costs on the loan.  These costs are even higher if you borrow more than 60% of the available proceeds in the first year.
• Going forward, you will continue to pay regular servicing fees, and interest owed on the loan will grow on a monthly basis.
• The interest rate charged on the loan may change over time (most have variable rates).
• Reverse mortgage income may impact your eligibility for Medicaid or Supplemental Security Income benefits.
• Since you keep the title on your home, you are still responsible for home maintenance and repairs, property taxes, insurance, etc.  If you neglect any of these, the lender may require the loan to be repaid.
• A spouse or other family member living in the house could be forced out when you die or move out (such as if you needed to move into assisted living), unless they can afford to repay the loan.  Even if spouses are allowed to stay in the home (e.g. in the case of some HECMs), they will not continue to receive payments from the lender if they were not part of the initial loan agreement.

There are many reasons to hesitate before taking out a reverse mortgage, but it still may be a sensible option in some cases, especially if you are in the later stages of retirement and can have some assurance that you will be able to stay in your home until life expectancy.  However, if a spouse, adult children, or other family members are living in the house, they must be part of the discussion and understand how they may be impacted if a reverse mortgage becomes due.  Furthermore, as Nick Clements of Forbes warns, “Don’t underestimate how quickly a reverse mortgage’s compounding interest erodes your equity.”  Consider whether downsizing your home; obtaining a home equity loan, line of credit, or cash-out refinance; or finding some other source of income may be a better solution–not just for you, but for your heirs as well.