By Elliot M. Kass | American Express Credit Intel Freelance Contributor
5 Min Read | November 30, 2020 in Money
Reverse mortgages allow homeowners age 62 and up to access the equity in their homes as cash, without having to move.
These loans help fund retirement for seniors who want to remain in place.
But reverse mortgages aren’t suitable for everyone – they can be expensive and may put the borrower’s dependents at risk.
People age 62 and older who have owned their homes for many years are sometimes drawn to the idea of taking out a reverse mortgage to help fund their retirement. Reverse mortgages convert a portion of their home equity into cash that they can receive as a lump sum, as regular – usually monthly – payments, or as a line of credit.
While using a reverse mortgage can be a good idea for some older homeowners, there are risks and drawbacks that may make it unfavorable for others. Let’s take a look at the pros and cons of this retirement strategy, who is likely to benefit from a reverse mortgage, and who may be better off without one.
A reverse mortgage is a type of loan available to homeowners age 62 and up that have a substantial amount of equity in their home. To qualify, you must either own your home outright or be close to paying it off. Whereas a traditional mortgage is a way to get the funds you need to buy a home, a reverse mortgage allows you to sell your home without having to move out.1
With a reverse mortgage, you are borrowing against the equity you have built up in your home, which serves as collateral for the loan. In exchange for the cash you receive, the lender gets a share of the proceeds when the home is sold – either when you decide to move or when you die. Before then, you do not have to make any payments to the lender, although interest on the loan will continue to accumulate until the home is finally sold.
If you’re considering a reverse mortgage, you should also be aware that lenders typically charge substantial fees and higher-than-usual interest rates for this type of loan, and that the homeowner is required to take out an insurance policy to protect the lender. Compared to other types of loans, these costs make reverse mortgages a relatively expensive way to borrow money.2
The alternative to a reverse mortgage is to sell your home outright. This lets you cash out all of your home equity instead of only a portion of it. But you would also have to move, and moving is expensive – not to mention emotional, given you’ll be leaving your home to move to a potentially unfamiliar location. Also, you may not want to take on the financial burden of buying a new place, in which case you would have to rent or move in with relatives – options that may or may not appeal to you.
Generally speaking, there are three criteria to meet for benefitting from a reverse mortgage:
If you’re considering moving out for any reason, including health concerns, then you would likely be better off selling your home instead of using a reverse mortgage.
Likewise, if you want to protect a spouse younger than 62, other family members, or anyone else who lives with you from losing the home when you die, then a reverse mortgage is not your best option. Unless they can afford to pay off the loan at the time of your death, the lender will sell your home to recover its money and they will be forced to move.
There is an exception. Spouses who are not old enough to qualify as a co-borrower can still be listed as a non-borrowing spouse on the reverse mortgage. That means they can remain in the home when you die without paying back the loan, provided it's their primary residence. But there’s a catch, too. Because they're not a borrower, they won't be able to collect any more money from the reverse mortgage and will lose the income it provided. Without that income, they may no longer be able to afford the expense of maintaining the home and may have to move anyway.
If you’re an older homeowner who plans to stay put, a reverse mortgage may be a sensible way to help fund your golden years. This is especially true for seniors whose spouses are also over age 62 and can be listed as co-borrowers on the loan. But if you plan to move, have a younger spouse, kids, or other dependents who rely on your income, you may be better off selling your home or finding other ways to pay for your retirement.
1 “What to Consider Before Getting a Reverse Mortgage in Retirement,” U.S. News & World Report
2 “Are Reverse Mortgages Worth the Risk?,” The Motley Fool
3 “5 Signs a Reverse Mortgage Is a Good Idea,” Investopedia