The Pros and Cons of a Reverse Mortgage

Pros of a Reverse Mortgage

If you're considering a reverse mortgage, here are some of the perks that can make it worth your while.

Payments Aren't Taxable

The payments you receive from a reverse mortgage aren't subject to income taxes because they're considered loan proceeds. As a result, these payments can be a good way to supplement taxable retirement income to minimize your annual tax liability.

It's also a good alternative to selling your home if the value has appreciated significantly since you bought it and you're worried about a capital gains tax.

You Can Remain in the Home

Like a traditional mortgage loan, the title to the home remains in your name. You can even continue to make updates and renovations to the home without needing permission from the lender.

At the same time, if your health condition changes or you simply want a change of scenery, you have the flexibility to move if you choose to. You'll just need to repay the loan when you move or sell the home.

You'll Never Owe More Than the Home Is Worth

If you remain in your home for a long time, it's possible that your reverse mortgage loan balance may eventually grow larger than the value of your home. However, the good news is that most reverse mortgages are considered "non-recourse" loans. In other words, the lender can't demand that you or your heirs pay a penny more than the home is worth.

Cons of a Reverse Mortgage

While there are some clear benefits to taking out a reverse mortgage, it's also important to consider the potential downsides before applying.

You'll Need to Meet Certain Requirements

A home equity conversion mortgage (HECM), which is the most common type of reverse mortgage, has several requirements you need to meet to qualify, some of which include:

• The home must be your primary residence, even after you take out the loan.
• You must be at least 62 years of age.
• You must own your home outright or be able to pay off the remaining balance at closing.
• Your home must be in good condition—if not, you'll need to first pay for repairs.

If you don't meet all of these conditions, among others, you may need to consider some alternatives to a reverse mortgage—more on those later.

You'll Incur Various Costs

When taking out a reverse mortgage, you'll pay an origination fee, other closing costs paid to third parties and an upfront mortgage insurance premium, which amounts to 2% of your property value.

You'll also pay an annual mortgage insurance premium equaling 0.5% of your outstanding mortgage balance. Your lender may also charge you a monthly servicing fee of up to $35 in addition to the interest that accrues over time.

On top of that, you'll need to continue to maintain homeowners insurance, pay property taxes and keep up with home maintenance and repairs. Not complying with this requirement may result in foreclosure.

It Could Impact Your Heirs

If you remain in your home until you pass away, your heirs may be responsible for paying off the debt you incurred. While they can do this by simply selling the home, they may also choose to pay it off on their own to keep the property. Either way, it may leave your loved ones with a reduced inheritance or none at all.

Is a Reverse Mortgage a Good Idea?

It's important to understand your situation and consider both the advantages and disadvantages of a reverse mortgage to determine if it's the right choice for you. To help you make your decision, here are some scenarios where it may or may not be worth it.

It's a good idea to consider a reverse mortgage in these situations:

• You don't plan to move. You can make the most of a reverse mortgage if you stay in your home for the long term.
• Your retirement income is inadequate. If your retirement savings, Social Security income and other resources aren't enough to meet your everyday expenses, a reverse mortgage can supplement what you already have. It could even be a good way to delay Social Security payments until you reach full retirement age.
• You're in poor health. If you have a medical condition, a reverse mortgage can help you keep up with health care costs, and even give you the funds to make accessibility modifications to your home.

Skip a reverse mortgage in these situations:

• You want to move in the near future. If you're looking to relocate in the next few years, it might not be wise to saddle yourself with a reverse mortgage, especially with all the upfront costs.
• You can't handle the costs. Closing costs, maintenance expenses, homeowners insurance and property tax bills could strain your already stretched budget.
• You hope to pass along your home to your heirs. A reverse mortgage can complicate matters if you want to leave your home to your kids or other heirs.

Alternatives to a Reverse Mortgage

Before applying for a reverse mortgage, it's a good idea to research all of your options to make sure it's the right move. Here are some potential alternatives to compare:

• Use a cash-out refinance. Even if your home is paid off, you may be able to obtain a cash-out refinance loan, allowing you to access a significant chunk of your home's equity in the form of a lump-sum disbursement. Just keep in mind that, unlike a reverse mortgage, you'll be subject to income and credit requirements, and you'll also have a monthly payment.
• Take out a home equity loan or line of credit (HELOC). A home equity loan or HELOC might be a less costly way to tap into your home equity compared to a cash-out refinance. You'll also have similar eligibility requirements and a monthly payment.
• Sell your home. Selling your home at a profit and relocating to a smaller, less costly space could be the answer to your budget woes. You might even opt to rent a place so you can avoid the hassles of homeownership.
• Look at other income resources. Consider other ways to generate income, such as selling stocks, cashing out a life insurance policy, taking on a part-time job or applying for Social Security income.
• Reduce your expenses. Start by looking at your budget to pinpoint areas where you can cut back. If you're already on a bare-bones budget and still struggling, look into assistance programs offered by government agencies and community organizations in your area. You may be able to get help with a variety of costs, such as groceries, utilities, medical expenses and even property taxes.

Learn more >> How to Use Your Equity for Retirement Income

Maintain Good Credit to Keep Costs Down in Retirement

While your credit score isn't a major factor in determining eligibility for a reverse mortgage, it can have a direct impact on your costs with other types of loans. It can even influence your auto and homeowners insurance rates.

As a result, it's critical that you maintain a good credit score, even if you don't plan to borrow a lot of money anytime soon. With Experian's free credit monitoring service, you can keep track of your FICO^® Score^☉ and Experian credit report, making it easy to get insights into what's influencing your score and how you can improve it.