When Does A Reverse Mortgage Make Sense?

August 03, 2018

I was having lunch with a friend recently and he raised a question about reverse mortgages. His parents have been receiving mailers advertising the benefits of a reverse mortgage and he wanted to know if it was something they should explore. When this type of product was initially launched, they were considered to be a bad deal. But newer regulations have changed that, so it’s actually a viable consideration in certain instances. Here’s what I told him.

A reverse mortgage is a type of home equity loan that allows homeowners that are 62 or older to use a portion of their home equity to supplement their income and improve their cash flow each month by eliminating their mortgage payment. Here’s how they work.

The basics

  • The bank will make payments to the home-owner (or extend a line of credit) based on a percentage of equity the borrower has in their home. If you still owe on your traditional mortgage, that is paid off with the reverse mortgage, so the monthly mortgage payment ends.
  • You must be at least 62 years old to qualify, and your home must be used as your primary residence.
  • You should either have the home paid off entirely or only a small mortgage remaining.
  • The loan is payable when you:
    • Pass away,
    • Sell the home, or
    • Permanently move out (aka it is no your longer primary residence for more than 12 months)
  • Funds can be used for any purpose – common uses are to supplement income, pay for health care expenses, pay off debt, or pay for home maintenance/improvement projects.
  • You can never owe more than the value of your home, no matter how much you borrow.
  • You are required to participate in mandatory counseling from a third party to explore your options before committing to a reverse mortgage.

How much can you borrow?

The amount you can borrow through a reverse mortgage depends on several factors, including:

  • Your age (will be based on the age of younger spouse if you’re married).
    • Generally, the older you are, the more you can borrow.
  • The value of your home.
    • Limited to the lesser of the appraised value or $636,150.
  • Interest rate.

What does it cost? (aka what are the cons)

This is a critical issue to be aware of if you are considering a reverse mortgage. It is common to see higher closing costs (origination fees, upfront mortgage insurance and appraisal fees) and the interest rate is generally higher than with a traditional mortgage.

Also, you remain responsible for property taxes, insurance, and maintenance costs. And, if you want the home to stay in the family after you’re gone, a reverse mortgage can make that more difficult as the loan needs to be paid at your passing – that may mean the home needs to be sold if no other funds are available.

Does it make sense for you?

A reverse mortgage can be an effective retirement planning tool if you:

  • Don’t plan to move.
  • Can afford to pay property taxes, insurance and the costs of maintaining the home otherwise.
  • Want to improve cash flow or supplement income to pay off debt or pay for other expenses.

On the flip side, a reverse mortgage may not make sense if you:

  • Plan to move or want to keep the home in the family (and your estate would have no other means to pay off the reverse mortgage).
  • Can’t afford the costs of home maintenance, even without a mortgage payment.
  • Don’t have cash available to pay the costs to take out a reverse mortgage.

Final thoughts

In talking to my friend, it turns out a reverse mortgage was not the right fit for his parents and their situation. But, it is good to keep all options open and know what resources you have available to generate income in retirement.

It is a good idea to explore other sources of income before looking at a reverse mortgage. Spend down your retirement savings and try to reduce your expenses first. If you still have a shortfall, a reverse mortgage may make sense for you.