A reverse mortgage is a great loan product, but it’s not the right solution for everybody. Is it right (or wrong) for you? We’ll cover the reverse mortgage pros and cons to help you make an informed decision about whether it’s the right solution for you.
As an experienced industry professional, there have been many cases where I’ve recommended to clients that they explore other options. I pride myself in giving an honest assessment about whether a given product, whether it’s a reverse mortgage or other mortgage product, is the right solution. I’ll be just as forthcoming in what we’ll cover in this article.
There is quite a bit of information in this article, so we’ve included the following table of contents to make it easier to navigate. We’ve also included “Back to Top” links throughout the article so it’s easier to return to the top of the page.
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Table of Contents
Assessing Reverse Mortgage Pros and Cons
When weighing the reverse mortgage pros and cons, I think the positives overwhelmingly win. Most seniors who have significant home equity can benefit from a reverse mortgage in at least some way. In my opinion, the reverse mortgage offers a large number of positives, has a few negatives, and has several perceived negatives that really aren’t negatives.
Before we dig into some reverse mortgage pros and cons, let’s first cover what a reverse mortgage is and how it works. There is a ton of misinformation out there about reverse mortgages. Many of the perceived negatives are, in reality, based on misinformation.
What is a Reverse Mortgage?
A reverse mortgage is a unique mortgage product designed to give you access to your home equity without a mortgage payment. The most popular reverse mortgage in the United States is the home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). If somebody you know recently got a reverse mortgage, they likely got a HECM.
The HECM program was created and signed into law by President Ronald Reagan as part of the Housing and Community Development Act of 1987. The Federal Housing Administration (FHA) insures and regulates the HECM under the authority of the Department of Housing and Urban Development (HUD).
Over 50,000 seniors get HECMs every year in America today. That number will likely grow as more seniors learn about the program.
How Does a Reverse Mortgage Work?
First of all, a HECM is simply a home loan. It’s a unique home loan that unlocks your home equity so you can use it to enhance your retirement lifestyle and financial security.
No mortgage payments are required as long as at least one borrower lives in the home and pays the required property charges.
You always remain the title owner of your home. You can leave your home to your heirs and they can either choose to keep it or sell it. If your heirs wish to keep the home, they can pay off or refinance the reverse mortgage balance. If your heirs don’t want the home and don’t want to mess with selling it, they can let the lender sell it. Once the lender sells the house, the loan balance is paid off, and any remaining equity goes into your estate.
The HECM is a non-recourse loan. The most that will have to be repaid is the value of your home. FHA will cover any shortage if your home isn’t worth enough to pay off the entire loan balance.
The HECM is highly customizable; you can tailor it to your individual financial goals and needs. You can take the proceeds as a lump sum, line of credit, term/tenure income, or a combination of these options.
HECM proceeds are not subject to income taxes and have no impact on Medicare or Social Security retirement benefits. It is possible, however, that a reverse mortgage can impact Social Security Disability benefits. If you receive such benefits, be sure you understand how a reverse mortgage could impact them.
Now that we’ve covered the basics, let’s dig into some reverse mortgage pros and cons.
Reverse Mortgage Pros
A reverse mortgage is a great loan product largely because it’s so versatile. It offers many options that can accomplish many different things. Whether or not a reverse mortgage makes sense for you depends on your circumstances and goals. The following summarizes some reverse mortgage “pros” that may be beneficial for you:
- Tap into equity without a mortgage payment. As mentioned, a HECM reverse mortgage unlocks your home’s equity without a mortgage payment. What other loan product does that?
- Get rid of an existing mortgage payment. Remember, the HECM doesn’t require a mortgage payment as long as you live in the home and pay the required property charges. Many seniors have mortgages that will likely last longer than they will. What’s the point of paying a mortgage you may never pay off anyway? If you can get rid of a mortgage payment, you have more money to cover unexpected expenses and do fun things.
- Get rid of credit card, auto, and consumer loan payments. We all know that credit cards have high interest and are often a nightmare to pay off. Auto and consumer loans often come with high payments that can limit your lifestyle and financial flexibility. Many HECM borrowers use the proceeds to get rid of consumer debt which has become a headache.
- Fund home improvements. A house requires periodic updating and maintenance that can be expensive. Because no payment is required, a reverse mortgage is a great way to tap your home’s equity and reinvest it back into your home. Many HECM borrowers use the proceeds to replace their roof, air conditioner, or update the kitchen and bathrooms.
- Pay off medical bills. Unfortunately, Medicare doesn’t cover medical care like hearing aids and dental work, which can be extremely expensive. A HECM is a great way to pay for medical expenses not covered by Medicare.
- Prepare for long-term care. I’ve worked with several seniors who set up a HECM in anticipation of long-term care expenses in the future. Long-term care can be $5,000 to $7,000 or more per month. Experts say that the last six months of your life could be the most expensive because of long-term care needs. A HECM is a great way to prepare for that potential expense.
- Supplement retirement income. A HECM can provide monthly term or tenure income, which supplements your retirement income. More income means more fun, right?
- Supplement retirement assets. The HECM line of credit can supplement your existing retirement assets. Nobody knows how they’ll live and nobody wants to run out of money before they die. The HECM adds home equity to the retirement funding picture. Instead of living on just pensions, Social Security, IRAs, 401(k)s, etc., you can also live on your home equity as well.
- Non-recourse. Most mortgage products are full recourse; the lender can come after you for the shortage if your home doesn’t sell for enough to pay off the entire loan balance. The HECM is non-recourse. You, your heirs, and your estate are not on the hook if your home doesn’t sell for enough to pay off the entire loan balance.
- Multiple payout options, with the line of credit being the best (in my opinion). A HECM reverse mortgage is customizable based on your financial needs and goals. As mentioned already, you can take the proceeds as a lump sum, line of credit, term/tenure income, or some combination of these options. In my opinion, the line of credit is far and away the best because it automatically grows and compounds larger over time.
Reverse Mortgage Disadvantages
Now that we’ve covered the positives, what are some potential downsides to a reverse mortgage? I can think of two. One applies to most reverse mortgages and the second applies to reverse mortgages that have been around a long time.
- Closing costs. Reverse mortgage closing costs can be expensive, but they’re not always expensive. The biggest closing cost is usually the initial mortgage insurance premium, or IMIP. IMIP, along with MIP, is what makes it possible for the HECM to be non-recourse. FHA uses IMIP premiums to cover shortages when homes don’t sell for enough to pay off entire HECM balances. You’ll likely also incur third-party costs and origination fees. Though HECM closing costs can add up, they’re usually not paid out of pocket. Most lenders are happy to pay them with the proceeds of the loan. The exception is HECM for purchase; closing costs are paid out of pocket in addition to your down payment.
- Interest can pile up on large loan balances. If you have a large reverse mortgage balance, the interest can pile rapidly up in the later years of the loan. Again, no mortgage payments are required, so unpaid interest accrues onto the loan balance over time. Interest compounds on top of interest, which means the loan balance can increase rapidly in the later years of the loan. Don’t forget, however, that the HECM is non-recourse. Even if you somehow owe more than your home is worth, FHA will cover the shortage.
Now that we’ve covered a few negatives, let’s cover some perceived negatives that really aren’t negatives.
When is a Reverse Mortgage Not a Good Fit?
Some people may consider what I’ll cover next “negatives” or “downsides”, but they’re not, in my opinion. No financial product is perfect for every situation. If a reverse mortgage is not a good fit for you, that doesn’t mean it’s a bad product. It’s just not the right solution for you. The following summarizes scenarios where a reverse mortgage make not make sense:
- You want the leave the most home equity possible to your heirs. The purpose of a reverse mortgage is to convert home equity into cash, which means the balance increases and your home equity decreases over time. If you wish to leave the most equity possible to your heirs, then a reverse mortgage doesn’t make sense.
- You plan to move soon. There are no prepayment penalties or limitations on selling, but a HECM is best suited for homeowners who don’t plan to move in the near future. Most HECMs have at least some closing costs, so you want to be in the loan long enough to recoup them and see some benefit. If you know you will be selling soon, it’s probably best to wait until you buy a new home to get a reverse mortgage.
- You need to borrower a small amount of cash and you plan to repay it quickly. A reverse mortgage is probably overkill if you need a small amount of money and intend to repay it quickly. A better solution might be a home equity line of credit (HELOC) or a personal loan. If you do opt for a HELOC, be sure to repay the money before the end of the draw period to avoid potential payment headaches. HELOC payments often increase substantially at the end of the draw period.
- You have a disabled relative living with you. A reverse mortgage may be a bad idea if you have a son or daughter or other relative living with you who can’t care for themselves. If something happens to you, they will 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’re no longer living in the home and paying the required property charges. If you have a disabled relative living with you, you may want to consider taking out a life insurance policy to repay the HECM balance after you pass away.
- Your home is in poor condition. A HECM reverse mortgage likely isn’t workable if your home is in poor condition. FHA governs the program and has minimum qualification standards that your home must meet. If your home is in poor shape, a hard money or rehab loan might be a better solution. You will have a monthly payment, but you could refinance into a reverse mortgage later once the home repairs are complete.
Reverse Mortgage Calculators
If you’d like to estimate how much you can get from a reverse mortgage, check out our reverse mortgage calculator. We may be a little biased, but we think our calculator is the best on the web. No contact information is required!
If you’re interested in a HECM for purchase, check out our reverse mortgage for purchase calculator.
If you’d like to calculate a simple principal limit, then check out our principal limit calculator.