A reverse mortgage allows people who are 62 and older to draw upon home equity in order to receive a chunk of money, a line of credit, or monthly income (or a combination of these), without having to pay back the loan until they die, move, sell the home, or breach the mortgage agreement. But is a reverse mortgage a good idea?
Here's the lowdown on reverse mortgages: what they are, how much you can borrow, as well as the upsides and downsides.
In a reverse mortgage or home-equity conversion mortgage (HECM), which is the most popular type of reverse mortgage, you trade equity in your home in return for money from a bank or other lender.
HECMs are FHA-insured, which means the insurance comes into play if the borrower defaults on your loan (breaches the mortgage agreement) or if the loan is accelerated (called due) for one of the reasons listed below and the house isn't worth enough to pay back the lender in full through a foreclosure sale. In those cases, the FHA will compensate the lender for the loss.
The lender's payments to the borrower may be in the form of a lump sum, monthly payments, or a line of credit you can draw on as needed, or a combination of these options.
The loan doesn't have to be repaid until:
After any of these occurrences, the lender may accelerate the loan and then the loan must be repaid plus interest and fees. Otherwise, the lender will foreclose.
Reverse mortgages are generally available to any homeowner over the age of 62 who has substantial equity in the home. Many reverse mortgages don't require a credit or income test. However, they do require financial counseling.
The amount you can borrow is based on your home's value, current interest rates, and your age. Also, there are limits to how much of your home's value you can draw out.
The most money available with a HECM is $636,150 (as of January 1, 2017)—no matter how much equity a person has in the home. Also, a borrower may get only 60% of the loan at closing or in the first year, subject to a few exceptions.
To determine if you are a good candidate for a reverse mortgage, consider the following:
How long will you live in the house? Closing costs on reverse mortgages can be high. So, if you plan to move in a year or two (an that event would terminate the reverse mortgage), it doesn't make financial sense to get a reverse mortgage.
Are you retired with a low income and a valuable house? Reverse mortgages are sometimes worthwhile for retirees whose incomes are low but whose houses are valuable.
Consider Edna, age 85, who owns her house outright. The house is worth about $500,000, but Edna's savings are almost exhausted and her Social Security income barely pays enough to cover her personal expenses -- with nothing left over to cover the costs of maintaining and insuring her house. Edna gets a reverse mortgage. She immediately borrows $10,000 so that she can replace her deteriorating roof, and then arranges to receive a payment of $1,000 per month. Even allowing for loan costs and interest, and assuming Edna lives into her mid-90s, she will not come close to exhausting her $500,000 in equity.
Reverse mortgages have certain advantages for some people, like if you have a lot of equity, but not much cash. Then a reverse mortgage might be a good way to get some spending money. But for most people, a reverse mortgage is a bad idea.
Reverse mortgages have significant downsides:
It's recommended that you proceed cautiously if you are considering taking out a reverse mortgage. Be sure that you know the risks and watch out for reverse mortgage scams—and consider talking to consider talking to a financial planner or elder-law attorney first.