Reverse mortgages offer a way to access the home equity you’ve built without selling your house. However, these loans can be complex and come with important trade-offs. Here’s what you should know before you pursue one, including how they work, the various types, and their most significant pros and cons.
What Is a Reverse Mortgage
A reverse mortgage is a special type of loan for homeowners who are 62 or older. It can help you turn your home equity into tax-free cash. Unlike a traditional mortgage, there are no required monthly mortgage payments.
Instead, the loan balance grows steadily as long as it remains outstanding, with the lender adding interest and fees to the amount each month. The lender then collects on the back end all at once, after a triggering event occurs.
How Reverse Mortgages Work
While you generally don’t have to make monthly payments on your reverse mortgage, the rest of the loan terms can vary significantly. For example, you may receive your funds as a lump sum, fixed monthly payments, or a line of credit.
The loan can also become due after several different types of events. However, the most common triggers include selling the home, moving out for a long period, or the death of the last borrower listed on the loan.
Types of Reverse Mortgages
Several types of reverse mortgages exist, but federally insured reverse mortgages are the most common. These loans follow federal guidelines and require counseling before closing. Some private lenders also offer proprietary reverse mortgages that aren’t federally insured.
In addition, single-purpose reverse mortgages may be available through some state or local programs. These loans often limit how the funds can be used, such as for home repairs or property taxes.
Basic Eligibility Rules
Reverse mortgage eligibility depends on a few factors, but the most important is that borrowers usually must be at least 62 years old. In addition, the home must be the borrower’s main residence, so you can’t use them on an investment property.
Ongoing duties remain with the homeowner, including property taxes and homeowners insurance bills that must be paid on time. The home must also stay in good condition.
Common Reverse Mortgage Pitfalls
Reverse mortgages may help some homeowners, but they carry risks, such as:
Reverse Mortgage Set Aside
Some reverse mortgages include a reverse mortgage set-aside. This is a portion of the loan proceeds that you must reserve for taxes and insurance. It may lower the risk of default, but it also reduces the amount of cash you can use.
Fees and Costs
Reverse mortgages may include upfront costs, such as origination fees and closing costs. These can also reduce the amount of capital you receive from the loan.
Growing Loan Balance
Interest and fees continue to accrue while the mortgage remains outstanding, causing the debt balance to grow. Over many years, this can significantly erode the equity balance in your home.
Risk of Default
Monthly mortgage payments are not required with a reverse mortgage, but borrowers still have obligations. Missing tax payments, letting insurance lapse, or failing to maintain the home can lead to default. In some cases, this may result in foreclosure.
Impact on Heirs
A reverse mortgage can affect your heirs after you die. When the loan comes due, they may need to repay the balance after refinancing the loan or sell the home. If equity is low, their choices may be limited.
Reverse Mortgage Issues to Consider
Reverse mortgage problems often stem from confusion about the terms. Long-term costs may not be clear at first. Federal rules generally require counseling before closing. This aims to explain how the loan works and which responsibilities the homeowner retains.
Final Thoughts
Reverse mortgages can offer valuable liquidity in retirement, but they can also have significant financial consequences, especially for your heirs. Do your research and speak with an expert counselor to understand how they work before applying.
