When your biggest asset is your home, a reverse mortgage can offer an attractive opportunity for income. However, it’s important to note the costs of a reverse mortgage and what happens to your home after you pass away. Here’s a closer look at the benefits of a reverse mortgage, so you can make an informed decision for your financial needs.
What Is a Reverse Mortgage?
A home equity conversion mortgage (HECM) is a type of home loan commonly referred to as a reverse mortgage. Unlike a traditional loan, the reverse mortgage results in a payment to the borrower every month rather than a payment from the borrower. As the borrower receives payments, the loan balance slowly increases over time. As with other loans, this balance accrues interest. To qualify for a reverse mortgage, the borrower generally is required to be at least 62 years old, maintain the home as their primary residence, and keep the property in good condition. A reverse mortgage can offer much-needed income for many years while the borrower remains in their home.
How Does a Reverse Mortgage Work?
A reverse mortgage is a home equity loan in which the lender makes payments to the borrower. That makes it unlikely you’ll run into problems with late or missed payments. However, borrowers are still responsible for loan interest, fees, property taxes, and homeowners insurance. The loan balance increases over time, and interest rates may not be fixed. That can lead to higher interest rates over time as your balance grows. Depending on your lender, you may have options for a monthly distribution (monthly payment to you), a single lump distribution, or a line of credit you can tap into for funds according to your needs and loan requirements.
5 Benefits of Reverse Mortgages
If you’re on the fence about a reverse mortgage, it’s essential to weigh the pros and cons this loan would have on your financial situation. The following are among the top benefits of a reverse mortgage loan.
Regular Retirement Income
Getting regular income without working can be a significant benefit if you own a home but don’t have extensive retirement savings and investments. You can use a reverse mortgage to supplement Social Security, pensions, and other retirement income sources, or as a sole source of income. For someone with a valuable home that’s mortgage-free and little other income, this type of loan can act as a critical lifeline to maintain their standard of living past their traditional working years.
Tax-Free Money
The proceeds of a reverse mortgage are not considered taxable income. That’s a benefit over taxable income sources such as Social Security, qualified withdrawals from a 401(k) or traditional IRA account, or work. Interest accrued on a reverse mortgage is generally not deductible because interest on home equity debt is not deductible unless the loan is used to buy, build, or improve the home.
Cash Out Equity Without Selling Your Home
Some retirees think the only way to get cash out of their home in retirement is to sell, but that’s not the case. With a reverse mortgage, you retain title to your home, which means you remain the owner of the house, and can tap into your home equity without moving or selling your home.
No Monthly Payments
If the loan has any monthly payments, they’re going to you, the borrower. The lender does all the paying (outside of interest and fees), and cash should only go out to the borrower. The loan doesn’t require monthly repayments, but must be repaid if you sell the house or all borrowers pass away.
Protection From Loss
A reverse mortgage offers some protection if the value of your home declines and your loan value exceeds what your home is worth. If you sell your home for the appraised fair market value, the difference is paid by reverse mortgage insurance. After the death of all borrowers, the reverse mortgage is required to be repaid. Typically, heirs do that by selling the house and using the proceeds to pay off the loan. Your heirs will have to repay the entire loan balance or 95% of the home’s appraised value, whichever is less, to keep the house after you pass away. If the value of the house is lower than the loan balance, mortgage insurance pays the difference.
The Bottom Line
While reverse mortgage loans have benefits, they have plenty of costs. Depending on your financial situation and what you want for your estate when you pass away, a reverse mortgage may or may not be the right choice. When in doubt, consult with a trusted financial professional who can guide you through the right choice for your unique needs. If you decide on a reverse mortgage, be aware that reverse mortgage borrowers are frequently the target of scams, and some reverse mortgage terms may be a rip-off for borrowers. Do your due diligence and understand what you’re getting yourself into before signing any contracts. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
