For homeowners approaching retirement, there may be a want or need to borrow against the equity established in the home in the form of a reverse mortgage. Some may wonder why you’d want to borrow against your home equity, especially if the house has already been paid off. However, reverse mortgages can be useful financial tools for seniors who need extra income but want to stay in their current home for as long as possible.
A reverse mortgage can offer both pros and cons, so it’s best to consider your options carefully before determining whether this loan option is right for you.
What Is a Reverse Mortgage?
A reverse mortgage is a type of home loan that allows homeowners to borrow against the equity—that is, the difference between the value of a property and the amount of money owed on it—in their home. By doing so, they can leverage the equity by withdrawing a portion of it without having to make repayments until they leave the property.
Typically, those who qualify for reverse mortgages have already paid off most, if not all, of their mortgage, allowing them to borrow part of the equity as tax-free income. In these cases, the lender pays the homeowner instead of the homeowner paying the lender each month.
Homeowners who are 62 years of age or older and have sufficient equity in their home may be eligible for a reverse mortgage. This can give seniors extra financial flexibility in retirement; they may use the loan proceeds to pay for home improvements, medical expenses, or other bills. Reverse mortgages can also help seniors delay taking Social Security benefits, which can increase their overall retirement income.
How Does a Reverse Mortgage Work?
One of the most common types of reverse mortgages is backed by a federal government program called the Home Equity Conversion Mortgage (HECM). Depending on your age, your home’s value, and current interest rates, this type of reverse mortgage can work in a few different ways.
One of the most important things to remember is that the amount a homeowner can borrow, or the principal limit, cannot exceed the HECM limit. This amount changes every year; for 2022, the HECM limit is $970,800. Homeowners looking to pursue a reverse mortgage cannot borrow more than this amount, even if the equity of their home is worth more.
If you are older and your property is worth more, you are likely to receive a higher principal limit and a lower interest rate. The HECM loan can have a fixed interest rate, where you receive a lump sum disbursement payment, or a variable interest rate. With a variable interest rate, homeowners have a few options, including:
- Equal monthly payments, as long as the borrower lives in the home as their primary residence
- Equal monthly payments for a set period of time that’s agreed upon when the loan is first acquired
- A line of credit that can be accessed any time and ends when the loan runs out
- A combination of fixed monthly payments and a line of credit that ends when you leave the home
- A combination of fixed monthly payments and a line of credit for a set period of time
Your lender can help you decide which option is right for you depending on what interest rate you receive at the time of acquiring the reverse mortgage.
Advantages of Reverse Mortgages
One of the biggest advantages of a reverse mortgage is that they do not require monthly payments like a traditional mortgage loan. Instead, the loan balance is paid off when the borrower dies, sells the home, or permanently moves out of the house. If the borrower dies before the loan is paid off, the lender can recover its losses by selling the property.
Reverse mortgages also allow homeowners to stay in the house and tap into the equity they have built over the years to pay for other expenses. For seniors, this is a huge advantage since they don’t necessarily have a primary source of income. Instead, they can use the loan to cover living expenses while still living in the house and enjoying the benefits of retirement.
Additionally, reverse mortgages do not have certain income or credit score requirements. The proceeds from the loan are also usually tax-free, and a non-borrowing spouse can still remain in the home even if the borrower dies.
Disadvantages of Reverse Mortgages
Reverse mortgages are not without risk. In fact, there are many disadvantages of reverse mortgages that you should be aware of to ensure your options are being weighed carefully.
First, there are various costs associated with acquiring a reverse mortgage. The lender will charge certain fees, including an origination fee, a mortgage insurance premium, and other third-party and servicing fees. Depending on the amount of the loan, these fees can be relatively high.
Additionally, if the borrower fails to maintain the property or moves out of the home, the reverse mortgage must be repaid. For those who may not live in the same home long term, this can be a huge disadvantage.
Finally, taking out a reverse mortgage can reduce the inheritance you leave to your heirs. If you have children or grandchildren counting on inheriting your home, a reverse mortgage may not be the right choice for you.
Reverse Mortgage Requirements
As you consider whether a reverse mortgage is right for you, there are some requirements that borrowers usually have to meet, including:
- You must be at least 62 years of age or older
- You must either own your home outright or have a considerable amount of equity available
- You must live on the property as your primary residence
- You must complete a financial assessment/counseling session required by the U.S. Department of Housing and Urban Development.
In addition to these conditions, homeowners must also immediately use funds from the reverse mortgage to pay off any other mortgage loan they have, as well as continue paying for property taxes, home insurance, and home maintenance.
Before taking out a reverse mortgage, it’s important to understand both the advantages and disadvantages. Weighing your options carefully can help you make the best decision for your unique financial situation.
If you’re interested in pursuing a reverse mortgage, contact First Fidelis today at 913-205-9978, or get started with our pre-approval application.