With living expenses rising, many retirees are looking for ways to supplement their pensions. A reverse mortgage is one possible way to boost your retirement income. This type of loan allows you to convert part of your home equity into cash. The amount you receive depends on the value of your home.
A home equity conversion mortgage (HECM) is the most common type of reverse mortgage; it’s only available to people over 62. Unlike a traditional mortgage or home equity loan, where you make monthly payments to the lender, in a reverse mortgage or HECM loan, the lender makes payments to you as the borrower.
You can receive these payments in a lump sum, regular monthly payments, a line of credit, or a combination of these options. You don’t have to repay the loan until the last remaining homeowner moves out of the property or dies. So, for instance, if you're a married couple and one of you dies, you could still live in the property until you die or decide to move elsewhere.
At that time, the heirs usually sell the house to repay the reverse mortgage balance, and any remaining money stays with the current owners. The good news is that even if the home's value decreases, the repayment amount won’t typically exceed the home's value; this is because you will need to take out a mortgage insurance policy as part of your loan requirements, which will usually cover any discrepancies.
So, for instance, if your beneficiaries sold your home for $400,000 but owe $500,000, they won't need to repay the difference as the policy will cover this.
What is the AARP’s stance on reverse mortgages?
The AARP does not openly endorse or advertise reverse mortgage products on its website.
They believe reverse mortgages, even when transparent and well-designed, do not play a significant enough role in providing retirement security to most older people. This is a primary reason why retirees take this type of mortgage on.
But just because the AARP doesn’t endorse them doesn’t mean they’re not suitable for you. As with any financial product, reverse mortgages work well for some people and not for others.
Let's look at the benefits and drawbacks of reverse mortgages, alternatives to reverse mortgages, and alternative providers to consider if you have your heart set on one.
What are the benefits of a reverse mortgage?
A reverse mortgage offers several benefits, especially if you’re seeking additional retirement income. These include:
- No monthly mortgage payments
- Being able to stay in your home and access its equity
- The option to earn tax-free income
Let’s take a look at these benefits in a little more detail.
No monthly mortgage payments
Unlike traditional mortgages, with a reverse mortgage, you won't have to make monthly payments or installments on the loan balance. This frees up cash and means you can spend the equity from your house however you like.
Stay in your home and access its equity
A significant benefit of a reverse mortgage is that you can continue living in your home while accessing its equity. Typically, the only way to access the equity in your home is by selling it, which often involves downsizing. A reverse mortgage is a way to "have your cake and eat it."
Earn tax-free income
The money received through a reverse mortgage loan is considered a loan, not income, so it's generally tax-free. It also typically doesn't affect Social Security or Medicare benefits. For example, this can be an effective way to supplement your pension annuity.
These are just some of the benefits of a reverse mortgage. At its core, this product can provide financial security in your older age. But it's only suitable for some.
What are the disadvantages of a reverse mortgage?
There are several downsides to a reverse mortgage that you need to think about. These include:
- High upfront and ongoing costs
- The lender can inspect your home and request repairs
- Reduced inheritance for your loved ones
- Strict occupancy requirements
Let’s look at these drawbacks in a little more detail.
High upfront and ongoing costs
Reverse mortgages typically come with higher upfront costs than other types of mortgages. They also usually come with several ongoing costs.
Origination fees
First, you'll need to consider the origination fees lenders charge to process loan applications. They can cost between 0.5% to 1% of the loan amount.
Mortgage counseling fees
You’ll also need to account for mortgage counseling fees. The US Department of Housing and Urban Development (HUD) states that everyone applying for a reverse mortgage must attend a mortgage counseling session to understand the pros and cons of this type of loan. On average, a mortgage counseling session costs around $125.
Closing costs
There will typically be real estate closing costs to budget for as well. These will go towards credit checks, appraisals, surveys, and other essential checks.
Servicing fees
Once you've taken out the loan, you'll also need to budget for servicing fees. These admin fees go towards account statements and ensuring you're meeting other loan requirements. You can expect to pay between $30 and $35 on service fees, depending on whether you're on a fixed-rate or variable rate.
Insurance policies and property taxes
You’ll also need to look into homeowner’s insurance policies and budget for mortgage insurance premiums and property taxes. Keeping up with these costs is vital to remaining eligible for your loan.
The lender may inspect your home
As part of the conditions of your mortgage, you will need to keep your home in good repair. The lender can inspect your home and tell you to make repairs if they believe these are necessary. You will be responsible for the costs of these repairs. If you are struggling, there are nonprofit organizations like your local Area Agency on Aging that can help.
Reduced inheritance for your children
One of the most significant downsides to a reverse mortgage loan is that you reduce the inheritance you'll leave behind when you die. Your children may not be able to keep your home or profit from its sale as a result. They may need to sell it to pay back what is owed. This is usually the loan balance or 95% of the home's appraised value.
Occupancy requirements
You'll need to consider occupancy requirements as part of the eligibility requirements for a reverse mortgage. When you have a reverse mortgage, your home has to be your primary residence. That means you're only allowed to be away from your home for a specific period.
For example, if you are away from your home for more than six months for non-medical reasons, the lender will no longer consider this your primary residence, and you may need to repay the loan. This is something to remember if you plan on traveling extensively throughout your retirement.
Equally, if you go into long-term care for more than 12 months, your home will no longer be considered your primary residence, and you'll need to repay the loan.
What are some alternatives to reverse mortgages?
If you’re not sure a reverse mortgage is the right way to go, you may want to consider some of the alternatives below:
- Take out a home equity loan
- Downsize
- Take out a home equity line of credit (HELOC)
- Sell to family members
Let’s take a closer look at these alternatives.
Take out a home equity loan
A home equity loan is when you borrow against the equity of your property. If your property is worth more than your outstanding mortgage balance, you can take out a fixed-term home equity loan to use that equity.
You will need to make monthly repayments, much like you'd need to repay your mortgage. Bear in mind that a home equity loan is basically a second mortgage. As such, if you can't keep up with payments, you may risk foreclosure on your home.
Downsize
If you want to avoid taking out new loans or refinance, it might be time to look at the real estate market near you. If just you and your partner will be living in the property, downsizing could be an option.
You could sell the family home and opt for a smaller property that suits your needs better. You'll typically be left with a small amount of money after you buy a smaller house. You could use this to fund your retirement without worrying about meeting the stringent eligibility criteria of reverse mortgages. Also, your children could inherit the single-family property you buy after you die.
Take out a home equity line of credit (HELOC)
While both reverse mortgages and home equity lines of credit use your property's equity to offer you a loan, there's a significant difference between the two.
A home equity line of credit, or a HELOC, is a revolving line of credit similar to a credit card. It allows you to borrow against your home's equity. However, HELOCs typically have variable interest rates and require regular payments.
On the other hand, reverse mortgages don't typically require any payments until you either no longer live in the property or die.
They're used for different purposes as well. For instance, you may use a reverse mortgage to partially fund your retirement. On the other hand, a HELOC typically covers short-term borrowing needs.
Sell to family members
If you want to keep your property in the family and don't want to refinance or get another loan, you could sell your home to your children. You could then use the money from the sale to pay your children rent and continue living in the property.
This arrangement is a sale-leaseback. It is one way to make sure your children or close family members get to keep the property after your death.
These are just a few options to consider instead of a reverse mortgage, depending on your needs.
Non-AARP reverse mortgage alternatives
While the AARP does not endorse reverse mortgage products, other senior organizations and government bodies provide lists of reverse mortgage lenders you can look into.
Association of Mature American Citizens (AMAC)
If you’re a member of the Association of American Citizens (AMAC), you may be able to apply for a reverse mortgage through their sponsor Liberty Reverse Mortgage. Liberty Reverse Mortgage is a direct lender rather than a broker. They also align with AMAC’s mission to “protect and enrich the lives of seniors.”
Home Equity Conversion Mortgage (HECM) through the FHA
The Home Equity Conversion Mortgage (HECM) is a reverse mortgage product offered through the Federal Housing Administration's approved lenders. The HECM program allows you to withdraw some of your home's equity for improvements, repairs, or general living expenses. You can find an approved lender via the HUD Lender List Search.
The main benefit of this type of mortgage is that their lenders carry a stamp of approval from the federal government, which significantly reduces the risk of falling for a scam.
Proprietary reverse mortgages
HECM products available through the FHA are only available for properties valued up to $970,800 as of 2022. If your home is worth more than that, you may need to look at a proprietary reverse mortgage. You may get higher loan proceeds as you can borrow more.
But this type of mortgage is not federally insured, nor does it typically need to meet the stringent conditions that HECM products meet. Fees tend to be higher, but so are borrowing limits.
Just because this product is not federally insured doesn't mean it's a scam. Still, you should take extra care when researching providers. It may be worth speaking to a financial planner and discussing your other options before opting for this type of loan.
AgeGroup: Find reliable products and solutions with us
Here at AgeGroup, we're all about making it as easy as possible to find solutions that work for the modern senior. We're developing partnerships and products to help you live your life to the fullest. So, if you're thinking about a reverse mortgage or simply exploring ways to make the most of your retirement, keep in touch with us to learn more when the time comes.
Reverse mortgages: Are they right for you?
Reverse mortgages are complex financial arrangements that have significant implications. The benefits are that you enjoy your home's equity while still living there. But you'll need to keep up with property taxes, insurance, and repairs as set out by your lender. And you'll leave a smaller inheritance behind.
There are alternatives to reverse mortgages out there. But whether you choose a HECM, a proprietary reverse mortgage, or downsizing, it may be a good idea to get financial advice, so you know all your options and the consequences of your choices.
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