Based on research from leading reverse mortgage professionals Harlan Accola and Dan Hultquist
This article does not constitute tax or financial advice. Please consult a tax and/or financial advisor regarding your specific situation.
Reverse mortgages are the unsung heroes of retirement planning. These mortgages give homeowners 62 and older the option to eliminate monthly mortgage payments, freeing up hundreds or even thousands of dollars each month.
In fact, rather than making a monthly mortgage payment, you can choose to receive money, in the form of cash installments, a lump sum payment, or a line of credit, all secured by the equity you’ve built up in the home.
So why aren’t more senior homeowners clamoring for these loans? Well, reverse mortgages have also historically gotten a bad rap. But the reverse mortgages of today look much different than they did pre-2008.
That’s why it’s so important to separate reverse mortgage facts from fiction — so you can make an informed decision and avoid missing out on one of your greatest assets.
Fiction: Reverse mortgages are loans of last resort
Fact: They are a strategic retirement planning tool
A few decades ago, reverse mortgages were viewed as loans of last resort for borrowers who desperately needed cash and had only the equity in their homes to leverage for it.
Reverse mortgages have come a long way in recent decades. While they can still be a critical tool for homeowners who have low or fixed incomes, they’re also a valuable means of enhancing your retirement finances.
By receiving monthly cash advances or a line of credit from a reverse mortgage, you may be able to delay withdrawals from your retirement investment accounts. Not only does this give your investments more time to grow, cash advances from a reverse mortgage are not considered taxable income. Investment gains, on the other hand, are considered taxable income. So relying on reverse mortgage proceeds rather than making large investment withdrawals could help reduce your tax burden.
You can also use the money received from a reverse mortgage however you wish, including to fund lifestyle expenses, medical costs, and travel to spend time with your grandkids.
|Reverse mortgages defined: A reverse mortgage is a loan program for homeowners who are 62 and older that does not require a monthly payment and instead allows borrowers to receive monthly cash advances against the equity in their homes. You can also receive reverse mortgage proceeds as a line of credit or a lump sum amount.|
Fiction: Reverse mortgages are unsafe
Fact: They are safe and backed by none other than the U.S. government
The most common type of reverse mortgage is a Home Equity Conversion Mortgage (HECM). HECMs are insured by the Federal Housing Administration (FHA), which is overseen by the U.S. Department of Housing and Urban Development (HUD).
The FHA requires all HECM reverse mortgage borrowers to receive counseling from a HUD-approved counseling agency or HECM counselor before they close on the loan. The counselor makes sure borrowers understand the terms of their reverse mortgage.
Choosing a HECM is the safest path with a reverse mortgage because of the government insurance and counseling requirement. Lenders must be authorized by the FHA to make these loans, adding another layer of legitimacy and oversight.
From a financial perspective, reverse mortgages can be safer for retirees than forward mortgages or owning their homes outright, according to Harlan Accola, author of “Home Equity and Reverse Mortgages: The Cinderella of the Baby Boom Retirement.”
“From a safety perspective, a reverse mortgage is non-recourse and guarantees borrowers can stay in their homes for the rest of their lives as long as they live there and pay taxes and insurance, just like they would if their homes are paid off,” Accola writes. “Equity is often more highly valued than cash, but cash is the most important financial ingredient in retirement. You can’t use equity to buy gas and groceries.”
Even with a HECM, it’s important to work with a mortgage lender that is well-versed in these loans. The best reverse mortgage companies are highly experienced with reverse mortgages and working with retirees, and they will explain the advantages and terms in thorough detail.
Fiction: My spouse will be kicked out of our house if I die and they are not on the loan
Fact: You can include your husband or wife as a non-borrowing spouse, and they can remain in the home
Prior to the 2008 housing crash, non-borrowing spouses were not protected in a reverse mortgage. This meant that if, say, a husband took out a reverse mortgage but his wife was not yet 62 and could not be on the loan, the lender could foreclose on the property when he died, even if she wanted to remain in the house. Many widows faced a loss of their homes because of this lack of protection.
But they, along with the AARP, sued HUD and Wells Fargo, and the case led to the FHA changing the laws for HECM reverse mortgages. Now, a borrower can name their husband or wife as a non-borrowing spouse and enable them to remain in the home after the borrower dies. The reverse mortgage balance will not come due until the non-borrowing spouse dies or moves out of the home.
The original terms of the loan apply to the non-borrowing spouse, allowing them to continue living in the house without a monthly mortgage payment as long as they stay current with their taxes, insurance, and property maintenance and upkeep.
Fiction: I can’t pay down my reverse mortgage balance
Fact: Yes, you can
With a reverse mortgage, payments are optional.
You can make a monthly payment if you choose, and many reverse mortgage borrowers do. Making payments can increase your reverse mortgage line of credit and reduce the amount you or your heirs will owe when you leave the home.
But you don’t have to make payments. And without a mortgage payment, you have more cash on hand for your everyday expenses, medical needs, home upgrades to make the property more comfortable as you age, and travel to spend more time with family or seeing the world.
Fiction: My home goes directly to the government when I die
Fact: Heirs have the option to keep the home
A reverse mortgage does not entitle the government to your home. A HECM reverse mortgage is insured by the FHA, but it does not transfer ownership to the federal government.
Your heirs will receive the home as you intend, at which point they can decide how to handle the loan.
The balance of your reverse mortgage comes due when you leave the home or pass away, at which point you or your heirs will need to pay off the loan from your own funds or refinance to a traditional mortgage. You or they can also sell the home and pay off the loan with the proceeds of the sale.
Bear in mind that if you choose not to make payments, the loan balance will increase as interest accrues. A rising loan balance may not concern you if you plan to sell the home when you move out, or your heirs plan to sell when they inherit.
But if your heirs plan to keep the home in the family or move into it after you pass away, they will need to pay off the loan. They can do this from their savings or by refinancing to a traditional mortgage.
Get on the same page with your heirs
It’s important to discuss the terms of a reverse mortgage with your heirs if they plan to keep the home. They will need enough savings to pay off the loan or be in a position to qualify for a standard mortgage to avoid having to sell the home.
Another point to consider for your heirs: a chief risk of a reverse mortgage is that you can end up with little or no equity in the home. With a traditional, or “forward,” mortgage, the loan balance decreases over time as you make payments.
With a reverse mortgage, the loan balance will increase over time if you opt not to make payments toward the principal and interest.
If you intend for your children to sell the home and keep the proceeds from the sale, there may not be much leftover once they repay the loan.
Fiction: The lender owns the home, not me
Fact: You own the home as long as you abide by the reverse mortgage terms
A reverse mortgage is similar to a traditional mortgage in that the home remains in your name.
You receive funds from the lender — which is the “reverse” of a standard mortgage, in which you submit payments to the lender — but you’ll repay those funds when the last borrower leaves the home.
The lender can foreclose on the home if you don’t uphold the mortgage terms, but they do not own the home.
Fiction: I will lose money on a reverse mortgage
Fact: You can receive cash advances or a line of credit for as long as you live in the home
In addition to not having to make a monthly payment on a reverse mortgage, you can also receive cash or a line of credit from the loan.
A HECM gives you several options for how you access the money borrowed against your home equity:
- A lump sum payment after the loan closes
- A line of credit
- Monthly cash advances for as long as you live in the house (known as “tenure” payments)
- Monthly cash advances for a specific period of time (known as “term” payments)
- A combination of a line of credit and monthly cash advances
Now, you might be wondering why you would want to take out a reverse mortgage instead of a home equity loan or home equity line of credit (HELOC). After all, a home equity loan or HELOC also draws on the equity in your home and you can use the funds however you choose.
Reverse mortgage vs home equity loan and HELOC
The key difference is that with a home equity loan or HELOC, you owe monthly payments immediately after receiving the funds or using the line of credit. While those payments may seem manageable initially, especially if you’re still working, they can become a burden when you fully retire and have reduced income.
With a reverse mortgage, you can make payments if you choose. But if you opt not to make monthly payments as you adjust to a lower or fixed income, your credit won’t suffer and you won’t be at risk of default.
However, reverse mortgages may only be used on a principal residence. So if you want to borrow against a second property or vacation home, a home equity loan or HELOC would be the only viable options.
The combination of not owing a monthly payment plus having access to cash or credit with a reverse mortgage can augment your retirement cash flow and improve your quality of life even after you’ve stopped working.
And remember, money received from a reverse mortgage is not considered taxable income. So receiving cash advances or drawing on the line of credit will not increase your tax burden.
To summarize, let’s review the chief financial benefits of a reverse mortgage.
- Eliminates monthly mortgage payment requirement
- Frees up cash flow for other needs, such as healthcare, long-term care, repair and maintenance of a home, and retirement travel
- May help extend investment income
- Does not increase taxable income
Fiction: I can’t get foreclosed on if I have a reverse mortgage
Fact: Yes, you can
You can still lose your house in a foreclosure if you have a reverse mortgage.
Although you don’t have to make a mortgage payment, you still have to keep up with housing-related payments like property taxes, homeowners insurance, and homeowners association fees (if applicable). Failure to stay current with these expenses can result in foreclosure.
One reason reverse mortgages got a bad rap in the early 2000s was that senior citizens had their homes foreclosed on because they fell behind on their property taxes and insurance.
As Accola writes, that would have been a consequence regardless of whether they had a reverse mortgage.
“They would have lost their homes anyway because the county would have foreclosed, but the reverse mortgages were blamed,” Accola writes. “Lenders are required to file foreclosure by the FHA, which insures the product if the taxes are not paid.”
These days, lenders conduct thorough financial assessments to verify that a borrower has enough income to pay their taxes and insurance, as well as to maintain the property.
Upkeep and repairs are also conditions of a reverse mortgage, so a lender won’t approve you for these loans if they are not confident that you have sufficient income to meet these terms.
Additionally, HECM borrowers must complete counseling with a HUD-approved agency to ensure that they fully understand the commitment they’re making, the obligations associated with the loan, and the consequences of falling behind on their taxes, insurance, and maintenance.
Fiction: My children will be saddled with my reverse mortgage debt when I die
Fact: Reverse mortgages are non-recourse loans, so you or your heirs will never owe more than the home is worth
Another key feature of a reverse mortgage is that it is a non-recourse loan. That means that you or your children can never owe more than the property is worth.
If your loan balance is higher than the appraised value of the home, due to the interest accrued or because you opted not to make payments toward the principal, you (or your heirs) will only owe up to 95% of the appraised value. The FHA insurance will cover the lender for the remaining balance.
And, as mentioned above, your children get to decide what they want to do with the home. If they cannot or do not want to keep the property, they can sell it and use the sale proceeds to pay off the loan. Any profits above the loan amount are theirs to keep and use as they wish.
Fiction: Reverse mortgages have high upfront costs
Fact: You can roll some of your closing expenses into the loan
A reverse mortgage can be a far more affordable option than a traditional mortgage or home equity loan because of the optional monthly payment. Of course, just because there is no monthly payment requirement, a reverse mortgage isn’t free.
Before approving you for a reverse mortgage, lenders will assess your income and assets to make sure you have enough money for property tax, insurance, and maintenance and upkeep.
All borrowers who use the HECM program will pay an FHA mortgage insurance premium (MIP) as well. You’ll also need to factor in the costs of the loan, including the lender’s origination fee, servicing fees, and closing costs.
Fortunately, your MIP and some closing costs can be rolled into the loan, which reduces the amount of money you need upfront.
Fiction: Your reverse mortgage will never come due before you die or leave the home
Fact: Lenders can call in the loan if the home is no longer your primary residence or you fall behind on taxes and maintenance
As we’ve discussed, a core condition of your reverse mortgage is that you will continue paying property taxes and homeowners insurance even if you choose not to make monthly payments. You’re also required to maintain the property’s condition and ensure that any needed repairs are made.
If you fail to follow through on any of these conditions, lenders can call in the loan.
The home must also be your primary residence in order for the reverse mortgage terms to be upheld.
If you live in the home full-time when you take out the HECM, but decide a few years later to spend most of your time at a vacation home, the loan will come due.
The residence requirement applies even if you leave the home due to illness. For instance, if you move into an assisted living facility to recover from illness or injury and you live there for more than a year, the lender can consider that a “maturity event,” which means the loan balance becomes due.
Reverse mortgage pitfalls
Reverse mortgages are powerful retirement tools for many homeowners. They can make the difference between a comfortable retirement in which all your needs are met and one in which you limit your lifestyle and healthcare options for fear of running out of money.
However, reverse mortgages do have some pitfalls, and it’s important to see the full picture before deciding whether to take one out.
Do you want to own your home outright?
If you’re paying on an existing mortgage when you take out the reverse mortgage, you’ll pay off the first loan with the new one. And if you choose not to make payments on the reverse mortgage, you will never own the home free and clear.
If you currently own the home outright and then take out a reverse mortgage, you will effectively give up the peace of mind of knowing the home is yours free and clear. So you need to weigh the importance of that in your life.
But as Accola notes in his book, having equity in your home does not provide as much financial security as readily available cash or credit. Being able to tap into a monthly cash advance or line of credit provides flexibility and security as your needs change throughout retirement.
And a reverse mortgage is the only home equity product that lets you draw on your equity without having to make a monthly payment.
What are your heirs’ intentions for the home?
Another potential pitfall is the fact that your heirs may not be able to own the home when you die. If they cannot pay off the reverse mortgage or refinance to a forward loan, they will need to sell the house or initiate a deed in lieu of foreclosure to transfer the home to your lender.
However, most children choose to sell their parents’ homes when they inherit them. They would prefer their parents to live a more comfortable retirement than preserve equity in a house they aren’t going to keep anyway.
But if you hope to keep the home in the family, or you know your heirs want to keep the home, be sure to include them in reverse mortgage discussions with your financial planner and loan officer. Everyone who will be affected by the decision should be clear on the terms and obligations.
Be mindful to avoid scammers
Finally, because the reverse mortgage field can attract scammers, it’s critical that you discuss any reverse mortgage offers with a trusted financial planner and your family before signing anything.
Be wary of any unsolicited reverse mortgage offers, and research lenders independently even if they seem legitimate.
If you’re uncomfortable reading reviews or researching mortgage companies on your own, enlist your children or other trusted friends or relatives.
Avoid making any decisions about your home without consulting your financial planner or advisor first.
Reverse mortgage pros and cons
|No monthly payment required||Will not own home free and clear|
|Reduce taxable income*||Heirs will have to pay off or refinance the loan, or sell|
|Extend investment income*||Must still pay taxes, homeowners insurance, and maintenance expenses|
|More money for travel, renovations, time with family, quality long-term care, lifestyle needs||Need to strategize carefully to avoid spending money too quickly or losing out on government benefits|
Reverse mortgage FAQs
Reverse mortgages aren’t bad — they’re actually great options for increasing your cash flow in retirement and can help you make the most of your investment accounts by delaying your timeline for making withdrawals. But as with any loan, it all comes down to the details.
A reverse mortgage gives you an optional monthly payment — meaning you don’t have to make payments on the loan as long as you live in the home and keep up with property taxes, insurance, and maintenance and repairs. The loan balance doesn’t come due until the last borrower leaves the home or passes away.
A home equity conversion mortgage, which is insured by the FHA and is the most common type of reverse mortgage, is a non-recourse loan, so you (or your heirs) will never owe more than the home is worth.
Even with those benefits, however, a reverse mortgage isn’t right for everyone. If you may want to relocate in a few years or it’s important that the home stays in your family after you die, a reverse mortgage may not be the best option for you.
Home equity conversion mortgages are government-insured reverse mortgage loans, backed by the FHA. Before you can close on a HECM, the FHA requires you to receive counseling from an agency or counselor approved by the U.S. Department of Housing and Urban Development to ensure that you understand the terms to which you’re committing.
There are risks with any mortgage program. But a reverse mortgage enables you to stay in your home even if your income declines and you cannot afford a monthly mortgage payment. Assuming you keep up with the property taxes, insurance, and maintenance on the property, the loan will not come due until you leave the home, so there is less month-to-month financial pressure than you might experience with a traditional mortgage.
The amount of money you can receive depends on several factors, including how much equity you have in the home, your age, your interest rate, and how you choose to receive the funds (lump sum vs line of credit, for example).
It’s possible to lose your house with a reverse mortgage if you don’t keep up with the property taxes, homeowners insurance, and other housing-related costs such as HOA fees and maintenance and repairs.
However, reverse mortgages do not require you to make a monthly payment, so you cannot lose your home for not paying monthly installments. The loan only comes due when the last borrower leaves the home or dies.
What are the three types of reverse mortgages?
The three types of reverse mortgages are:
- The home equity conversion mortgage (HECM), which is backed by the FHA. This is the most common type of reverse mortgage
- A proprietary reverse mortgage, which is offered by private lenders and not backed by the government
- A single-purpose reverse mortgage, intended for specific uses (for instance, to improve sidewalks in front of a series of townhouses) and usually offered by government agencies or municipalities rather than lenders
Understand the opportunity
Reverse mortgages have significant advantages for homeowners who are 62 and older, including eliminating their monthly mortgage payment obligation and providing access to the home’s equity in the form of cash or a line of credit.
But these advantages need to be weighed against potential drawbacks, including the drawdown of the home’s equity.
To understand the opportunities that come with a reverse mortgage, and to determine whether it’s the right move for you, it’s important to work closely with a financial advisor and an experienced lender. They can help you evaluate your options in light of your finances, your goals, and the inheritance you hope to leave your family.
Fairway is not affiliated with any government agencies. These materials are not from HUD or FHA and were not approved by HUD or a government agency. Reverse mortgage borrowers are required to obtain an eligibility certificate by receiving counseling sessions with a HUD-approved agency. The youngest borrower must be at least 62 years old. Monthly reverse mortgage advances may affect eligibility for some other programs. This is not an offer to enter into an agreement. Not all customers will qualify. Information, rates and programs are subject to change without notice. All products are subject to credit and property approval. Other restrictions and limitations may apply. Equal Housing Opportunity.