The reverse mortgage is a great financial solution, but it’s not always a good fit. We’ll cover some basics about how a reverse mortgage works, correct a few common misconceptions, then cover some situations where a reverse mortgage may not make sense.
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What is a Reverse Mortgage?
A reverse mortgage is a unique home loan that enables homeowners 62 and older to convert a portion of their home’s value into cash.
The most popular reverse mortgage program in America today is the federally-insured home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders).
No mortgage payments are required as long as at least one borrower (or non-borrowing spouse) lives in the home and pays the required property charges.
You always remain the owner of your home and you’re free to leave it to your heirs. Your heirs will inherit the remaining equity in your home, whether they choose to keep it or sell it.
The HECM is a non-recourse loan, which means the most that will have to be repaid is the value of your home. FHA will pay the shortage if your home isn’t worth enough to pay off the entire balance.
The HECM is versatile and customizable; you can take the proceeds as a line of credit, lump sum, monthly term or tenure income, or some combination of all of these options.
Homeowners commonly use a reverse mortgage to eliminate existing mortgage or other debt payments, finance home improvements, or supplement existing retirement income or assets.
When a Reverse May Not Make Sense
Now that we’ve covered some basics, let’s cover some situations where a reverse mortgage may not make sense.
1) You Will Need Your Home Equity Later
The reverse mortgage is designed to convert home equity into cash, which means you’ll have less equity in the future with a reverse mortgage than without one. Again, that’s how a reverse mortgage is designed to work.
If you know you’ll need your equity in the future to relocate or move into a nursing facility, you may want to avoid a reverse mortgage.
2) You Want to Leave the Maximum Equity to Your Heirs
If you want to leave the most home equity possible to your heirs, then a reverse mortgage obviously doesn’t make sense.
Again, the reverse mortgage is designed to convert home equity into cash. Your loan balance will increase and your home equity will likely decrease over time.
3) You Have Dependents Living in Your Home
A reverse mortgage becomes due and payable in full when the last borrower or non-borrowing spouse is no longer living in the home and paying the property charges.
If you have children and/or disabled relatives living with you who won’t have the means to settle the loan balance after you pass, it’s probably best to avoid a reverse mortgage.
4) You Plan to Move in the Near Future
There are no prepayment penalties or limitations on selling, but a reverse mortgage is best suited for homeowners planning to stay in their homes long term. Much of the benefit comes out over time.
A reverse mortgage also comes with closing costs. It usually doesn’t make sense to incur closing costs if you’re not planning to keep the loan long term.
5) Lack of Financial Discipline
A reverse mortgage is probably a bad idea for homeowners who lack financial discipline. Homeowners with no financial discipline often burn through the proceeds quickly and end up in the same financial bind that prompted them to get a reverse mortgage in the first place.
Having said that, a reverse mortgage can be a great way to consolidate bills and eliminate payments. Many seniors take advantage of a reverse mortgage to get rid of debt payments accumulated as a result of financial hardships.
A Great Solution for the Right Situation
The reverse mortgage is a great financial solution, but it’s not always the perfect fit. If any of the above situations apply to you, it may be best to avoid a reverse mortgage for now.
However, if the above situations don’t apply to you and you have significant equity in your home, a reverse mortgage could be a great option.
Seniors commonly use a reverse mortgage to eliminate existing mortgage payments, pay off other debts (credit cards, car loans, etc.), finance home improvements and repairs, pay for medical care, pay for long-term care, and supplement existing retirement income and/or assets.
If you’d like to get an idea of how much you may be able to get from a reverse mortgage, check out our reverse mortgage calculator here.
