A reverse mortgage is a great financial solution, but it’s not always the right fit. Is it right (or wrong) for you? An industry insider explains reverse mortgage pros and cons and what to watch out for.
Like any financial product, there are pros and cons to a reverse mortgage. I’m an experienced industry veteran who has helped many seniors get reverse mortgages. I’ll cover the most important reverse mortgage pros and cons to be aware of as you evaluate whether a reverse mortgage is right for you.
If it turns out that a reverse mortgage doesn’t make sense for you, you may want to consider some alternatives. Feel free to also check out our article on potential reverse mortgage alternatives.
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Are Reverse Mortgages Bad?
A 2019 study by the Brookings Institution found a significant correlation between accurate information and a positive perception of the reverse mortgage. In other words, when seniors learn how a reverse mortgage really works, they like it – and they often choose to get one.
According to the study, 85% of respondents were satisfied or very satisfied with their decision to get a reverse mortgage.
The study results are surprising because they’re completely at odds with prevailing opinions about reverse mortgages. Most see nothing but disadvantages when it comes to reverse mortgages.
So, why the disconnect? Is it true that reverse mortgages are bad? Or is there something else going on?
In my experience, most people who think reverse mortgages are always bad simply misunderstand how they work. Part of my job as a reverse mortgage professional was correcting the rampant rumors and misconceptions my clients have heard about reverse mortgages.
So, before we can honestly evaluate the pros and cons of reverse mortgages, we need to be clear about how they actually work. Let’s first cover some basics, then we’ll dig into reverse mortgage pros and cons.
How Does a Reverse Mortgage Work?
A reverse mortgage is a unique home loan that offers homeowners 62 and older access to home equity without giving up home ownership or taking on a mortgage payment.
The most popular reverse mortgage today is the home equity conversion mortgage, or HECM (commonly pronounced heck-um by industry insiders).
The HECM was signed into law by President Reagan as part of the Housing and Community Development Act of 1987. Today, it’s regulated and insured by the Federal Housing Administration (FHA) and the Department of Housing and Urban Development (HUD).
No repayment is required as long as at least one borrower (or non-borrowing spouse) lives in the home and pays the property charges.
You remain the owner of your home and you’re free to leave it to your heirs. Your heirs can keep the home by paying off or refinancing the reverse mortgage balance. If your heirs don’t want the home, they can sell it, repay the reverse mortgage, and keep the remaining equity.
Your heirs can also let the lender sell it if they don’t want to keep the home or hassle with selling it.
The HECM is non-recourse, which means the most that will have to be repaid is the value of your home. FHA covers any shortage if your home isn’t worth enough to pay off the entire balance.
The HECM is flexible and customizable; your lender can tailor it to your individual financial goals and needs. You can take proceeds as a lump sum, line of credit, term/tenure income, or some combination of these options.
Seniors commonly use the proceeds to eliminate existing mortgage or other debt payments, fund home improvements and repairs, pay medical bills, supplement income, and supplement retirement assets.
How much you qualify for depends on your age, home value, current interest rates, and the HECM program you select. Older borrowers tend to qualify for more than younger borrowers.
The HECM also tends to offer more when interest rates are lower versus when interest rates are higher.
Again, a HECM reverse mortgage is just a home loan. You don’t give up ownership of your home, the bank doesn’t get the house in the end, and you can’t leave a big debt for your heirs to clean up.
Now that we’ve covered the basics, let’s cover the possible pros and cons of a reverse mortgage.
Reverse Mortgage Pros and Cons
So, what are the pros and cons of a reverse mortgage? What is the upside and what is the downside? In my opinion, if you assess the reverse mortgage pros and cons objectively, the “pros” will come out on top for most people.
However, no financial product is perfect. There are upsides and downsides to anything. We’ll first cover the upsides, then we’ll dig into the potential reverse mortgage downsides.
What Is the Upside to a Reverse Mortgage?
- Unlock home equity without a mortgage payment. Again, a HECM reverse mortgage unlocks home equity without a mortgage payment. No other home loan does that.
- Eliminate an existing mortgage payment. A reverse mortgage eliminates any existing mortgage payments. That gives you more money to do fun things and cover unexpected expenses.
- Eliminate credit card, auto, and consumer loan payments. Many retirees use a HECM to eliminate consumer debt payments, which frees up cash for other things.
- Fund home improvements. A reverse mortgage is a great way to tap into your home equity and reinvest it back into your home without having to take on a monthly payment. Many seniors use the proceeds to fund repairs and home improvements.
- Pay off medical bills. Medicare doesn’t cover hearing aids and dental work, which can be expensive. A HECM can help pay for medical expenses not covered by Medicare.
- Prepare for long-term care. Many seniors use the HECM to plan for future medical expenses. Long-term care can cost $5,000 to $7,000 or more per month. A HECM can help you prepare for that potentially huge expense.
- Supplement retirement income. A HECM can supplement your monthly retirement income. More income means more fun, right?
- Supplement retirement assets. The HECM line of credit can supplement your existing retirement assets. Nobody wants to run out of money before they die, right? The HECM helps your money last longer.
- Non-recourse. Most mortgage products are full recourse, which means you’re on the hook for the shortage if your home isn’t worth enough to pay off your mortgage balance. The HECM is non-recourse; FHA covers the shortage if your home isn’t worth enough to pay off the loan balance.
- Multiple payout options, with the line of credit being the best (in my opinion). As we’ve covered, you can take the proceeds as a lump sum, line of credit, term/tenure income, or some combination thereof. In my opinion, the line of credit is the best because it automatically compounds larger over time based on a guaranteed growth rate.
What is the Downside to a Reverse Mortgage?
We’ve talked about the upsides, but what are the disadvantages of reverse mortgages? Here are the two main downsides I came up with:
- Closing costs. When it comes to reverse mortgage pros and cons, this what you’ve probably heard about the most. Yes, reverse mortgage closing costs can be expensive, but they’re not always expensive. The biggest cost is usually the initial mortgage insurance premium, or IMIP. IMIP and MIP are what make the HECM non-recourse. You’ll likely also incur third-party costs and origination fees. HECM closing costs can add up, but they’re usually not paid out of pocket. Most lenders will roll them into the new loan. The exception is HECM for purchase; closing costs are paid out of pocket along with the down payment.
- Interest can pile up on large loan balances. If you have a large starting reverse mortgage balance (such as in cases where an existing mortgage is paid off), the interest can pile rapidly up in the later years of the loan. If you have no plans to sell, this probably won’t matter much. However, if you do foresee selling at some point, this could be one of the reverse mortgage disadvantages for you.
Notice I didn’t mention interest rates as a potential reverse mortgage downside. You’ve probably heard that reverse mortgage interest rates are sky-high. They’re not. Reverse mortgage rates are usually comparable to regular mortgage rates.
A Few Additional Things to Think About
Let me offer a few additional things to think about as you weigh the pros and cons of a reverse mortgage. It’s possible for a reverse mortgage to be both doable and beneficial, but it still may not make sense. Here are some scenarios where a reverse mortgage may not be the best fit:
- You want to leave the most equity possible to your heirs. The purpose of a reverse mortgage is to convert home equity into cash. This means the balance will increase and your equity will decrease over time. If you want to leave the most equity possible to your heirs, then a reverse mortgage obviously doesn’t make sense.
- Marrying after your reverse mortgage is complete. If you marry after you get a reverse mortgage, your spouse will not automatically “inherit” the protections built into the reverse mortgage. If something happens to you, your spouse will have to pay off or refinance the reverse mortgage balance or potentially lose the home. If you plan to marry in the near future, it may be best to get the reverse mortgage once you’ve tied the knot.
- You’ll need your home equity in the future. If you need to preserve your home equity for the future (because you plan to move, for example), then you probably want to avoid a reverse mortgage. Again, the reverse mortgage converts home equity into cash. This means the balance will increase and your equity will decrease over time.
- You have a disabled relative living with you. A reverse mortgage may be unsuitable if you have a relative living with you who can’t care for themselves. If something happens to you, they could lose the home if they can’t refinance or repay the reverse mortgage balance. Remember, the reverse mortgage balance becomes due and payable when you no longer live in the home and pay the property charges.
If the reverse mortgage pros and cons scale is leaning in the downside direction for you, it may be a good idea to consider some alternatives. Check out our article on potential reverse mortgage alternatives.
How Much Can You Get From A Reverse Mortgage?
As you consider the pros and cons to a reverse mortgage, you may want to also find out how much you can potentially get from a reverse mortgage. We have some great reverse mortgage calculators that are free to use with no contact information required. You can find our reverse mortgage calculator here. Our reverse mortgage for purchase calculator can be found here.