The Reverse Mortgage is a Great Product, But Here’s When It’s Best Avoided

The reverse mortgage is a fantastic financial product, but there are some situations where it’s best avoided.

Though I’ve made a living doing reverse mortgages, I will freely acknowledge that a reverse mortgage is not always the right financial solution. If I believe a reverse mortgage will benefit you, yes, I’m going to do my best to convince you of that :).

However, if it’s not a good fit, I will let you know that, too. I’ve always taken great pride in being equally forthcoming about the advantages and the potential disadvantages of a reverse mortgage for a given financial situation. There have been plenty of instances where I’ve advised seniors to avoid a reverse mortgage altogether.

So yes, the reverse mortgage is a great product, but there are some scenarios where it isn’t a good fit. Before I dig into what those scenarios are, let me first cover some basics. There is a lot of misinformation out there, so I want to make sure we lay some groundwork first. If you’re already familiar with reverse mortgages, feel free to skip over the next section.

What is a reverse mortgage?

A reverse mortgage is a unique home loan that enables seniors 62 or older to convert a portion of the value of their home 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 is living in the home and paying the required property charges.

You always remain the owner of the home and you’re free to leave it to your heirs. Your heirs will inherit any equity remaining in the home.

The HECM is a non-recourse loan, which means the most that will ever have to be repaid is the value of the home. If the home isn’t worth enough to pay off the entire balance, FHA will pay off the shortage.

The HECM is very versatile and can be tailored to your individual financial goals and needs. Proceeds can be received in the form of a line of credit, lump sum, monthly term or tenure income, or some combination of all of these options.

Seniors commonly use a reverse mortgage to get rid of existing mortgage or other debt payments, finance home improvements, or supplement existing retirement income or assets.

How does a reverse mortgage work?

So, how does a reverse mortgage work? First of all, it’s the opposite of what you’re used to. With a traditional “forward” mortgage, you borrow a large sum and pay it back in installments over time. The balance decreases and your home equity increases over time (assuming home values don’t fall, of course).

Reverse mortgages work in the opposite direction. You borrow money over time on an open-ended basis and you’re not required to make payments on the balance (as long as you meet your program obligations). Remember, “HECM” stands for home equity conversion mortgage. The whole point is to convert home equity into cash that can be used for other purposes. Instead of paying down the balance, your balance grows as you extract equity out of your home.

Like any other home loan, interest accrues on the money you borrow. Because you’re not required to make payments (as long as you meet your program obligations), any interest simply accrues onto the loan balance over time. HECM interest rates are typically comparable to traditional 30-year fixed mortgage rates.

When a reverse doesn’t make sense

Now that we’ve covered some basics, let’s cover some situations where a reverse mortgage may not make sense.

1) Lack of financial discipline

A reverse mortgage probably isn’t a good idea for seniors who lack financial discipline. Such seniors are better served by getting spending under control than tapping into new sources of cash that could result in even more spending.

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 mortgage and other debt payments and increase their monthly cash flow.

2) You will need your home equity later

The reverse mortgage is designed to convert equity into cash. This means you will have less home equity in the future then if you don’t get a reverse mortgage. You may even have zero home-equity at some point in the future.

If you foresee needing your equity in the future to relocate and buy another home or move into a nursing facility, then the reverse mortgage is better avoided.

3) You intend to leave the maximum home equity to your heirs

If your goal is to leave as much home equity as possible to your heirs as an inheritance, then obviously, a reverse mortgage doesn’t make sense. Again, the reverse mortgage is designed to convert equity into cash. Your loan balance will increase and your home equity will decrease over time.

4) You have dependents living in your home

Remember, the 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.

5) You plan to move in the near future

There is no prepayment penalty or limitation on selling, but a reverse mortgage is best suited for seniors planning to stay in their homes long term. Much of the benefit comes 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.

A fantastic financial solution for the right situation

If you have significant equity in your home and none of the above situations applies to you, a reverse mortgage could benefit you in at least some way. 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 important 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.

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