What if I said screwdrivers were bad and nobody should use them? You’d probably think I’m nuts, right? Or, what if I said that hammers were terrible and should always be avoided? Such a statement makes no sense, right? We all know that screwdrivers and hammers aren’t inherently good or bad, they’re just tools. Their “goodness” or “badness” is determined by how they’re used. A hammer is terrible for screwing in screws and screwdrivers are terrible for pounding in nails. However, both tools are incredibly useful when used for the right purpose.
The same applies to financial tools like the reverse mortgage. It’s unfortunate, but many people believe reverse mortgages are always bad and should never be used. Yes, a reverse mortgage can be bad if it’s used in the wrong scenario and/or for the wrong purpose – just like any other tool.
However, if it’s used for the right purpose, a reverse mortgage can be a fantastic financial tool that makes a positive difference in retirement for many seniors.
A Great Program, But Not Always the Perfect Solution
The HECM reverse mortgage is a great program, but it’s not always the perfect solution. There are some situations where it may not make sense.
In this article, I’d like to cover 5 scenarios where a reverse mortgage is probably better avoided. Then, I’d like to cover when a reverse mortgage can make a ton of sense for many seniors.
Before we dig into when a reverse mortgage may or may not make sense, let’s first cover what a HECM reverse mortgage actually is. There is a lot of misinformation about reverse mortgages out there, so I want to cover a few basics first.
What is a HECM Reverse Mortgage?
The most common reverse mortgage in the United States today is the FHA-insured home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). If somebody you know recently got a reverse mortgage, it very likely was the HECM.
The HECM reverse mortgage is designed to give homeowners 62 or older the ability to convert a portion of their home’s value into tax-free cash that can be used to eliminate mortgage payments (or other debt payments), supplement income or retirement assets, do home improvements.
No payments are required as long as at least one borrower pays the required property charges (property taxes, homeowner’s insurance, HOA dues, etc.) and lives in and maintains the home.
You always retain title ownership of your home, which means you can leave it your heirs. If your heirs wish to keep it, they can pay off or refinance the reverse mortgage balance. If they would rather not keep the home, they can sell and keep any remaining equity once the reverse mortgage is paid off.
If your heirs don’t want to keep the home or hassle with selling it, they can let the lender sell it. Any remaining equity will go to your heirs once the home is sold and the reverse mortgage repaid.
The HECM is a non-recourse loan, which means you’ll never leave a big financial mess to your heirs. If the home isn’t worth enough to settle the entire balance, the shortage is covered by the FHA insurance fund.
The HECM is very versatile and can be tailored to your needs and goals; proceeds can be received in the form of a lump sum, line of credit, term or tenure payments, or some combination of all of these.
5 Reasons a Reverse Mortgage May Not Make Sense
Now that we’ve covered the basics, let’s go over a few scenarios where a reverse mortgage may not be a good fit.
1) You want to leave as much home equity to your heirs as possible. The purpose of the reverse mortgage is to convert home equity into cash, which means your loan balance increases over time. Obviously, this doesn’t make sense for homeowners who wish to maximize the home equity they leave to their heirs.
2) You plan to move in the near future. There are no limitations on selling and moving once you have a HECM, but I think it’s a better option for homeowners planning to stay put for the foreseeable future. Many of the benefits of the HECM are realized over time. Qualifying involves some paperwork and effort on your part and there are usually some closing costs that have to be paid. The HECM isn’t designed to be a short-term financial solution.
If you know you’re going to be selling and moving within the next year or two, it’s probably better to avoid a reverse mortgage for now.
3) You need a relatively small amount of cash and plan to repay it quickly. If you need a relatively small amount of money and plan to pay it back quickly, a reverse mortgage could be overkill. A better solution might be a traditional home equity line of credit (HELOC). They’re usually faster, cheaper, and easier to obtain (as long as you’re well-qualified).
If you do opt for a HELOC, it’s a very good idea to repay what you borrow long before the end of the draw period. HELOC payments can increase substantially at the end of the draw period.
4) You have a disabled relative living with you. If you have a relative living with you who can’t take care of themselves, a reverse mortgage could force them out of the home if something happens to you. If you wish for them to continue living in the home after all borrowers have passed away, you may want to avoid a reverse mortgage unless you know they can repay (such as with life insurance proceeds) or refinance the balance. Again, the reverse mortgage has to be repaid in full once the last borrower permanently leaves the home.
5) You plan to get married in the near future. A new spouse is not automatically “grandfathered” into the protections and benefits of an existing reverse mortgage. If only your name is on the reverse mortgage, your spouse will have to settle up the reverse mortgage balance or move out of the home if something happens to you.
If you know you’ll be getting married soon, it’s probably better to avoid the reverse mortgage until you’re married.
When a Reverse Mortgage Does Make Sense
If you’re over 62, a homeowner, and none of the above items apply to you, a reverse mortgage could be a great option. If you owe less than half the home’s value (or nothing at all), a HECM reverse mortgage could substantially enhance your retirement lifestyle by giving you access to the equity in your home.
Many reverse mortgage borrowers use the proceeds to:
- Eliminate existing mortgage payments
- Eliminate other debts, such as credit cards and auto loans
- Finance home improvements
- Supplement retirement income
- Pay off medical bills
- Increase liquid retirement assets
- Set up a rainy day or emergency fund
- Take a vacation
Again, you always remain the owner of the home and are free to leave it to your heirs. As long as at least one borrower is living in the home and paying the required property charges, no payment or payback is required. It’s only after the last borrower permanently leaves the home that the reverse mortgage has to be repaid.
A reverse mortgage isn’t a perfect solution for necessarily everybody, but it can be a fantastic option for the right candidate.
