A reverse mortgage can be an important financial tool for seniors concerned that they may not have enough money available to them for retirement. With a reverse mortgage, older homeowners are able to convert part of the equity in their homes into cash, yet still maintain ownership of property. These funds can then be used tax free to either pay off debt and unexpected expenses or supplement monthly income.
But, though this relatively new form of financing may sound tempting, it is certainly not for everyone. Reverse mortgages come with many risks. Those who jump in too quickly can end up running out of money early on in their retirement, have no equity to fall back on nor give over to their heirs, and in some cases, they can even lose their property.
What is a Reverse Mortgage and How Does it Work?
As the name implies, reverse mortgages are a kind of home loan turned upside down. Unlike traditional mortgages, the homeowner is not the one making payments and growing equity.
Instead, the lender sends money to the borrower either through a lump sum, monthly installment, or a line of credit, while the owner’s equity in the home shrinks accordingly.
The balance on the loan does not have to be repaid until the borrower either passes away, sells the property, or permanently moves out.
The amount the homeowner will be eligible for is based on several factors, such as the value of the property, the age of the borrower, and the current interest rates.
To qualify, homeowners have to be at least 62, own their home completely or carry a mortgage balance that can be paid off by the new loan.
The Pros of a Reverse Mortgage
The greatest benefit reverse mortgages bring to retirees is financial peace of mind. Here is a rundown of some additional benefits reverse mortgages offer retirees:
- The homeowner can stay in the home
- There are no restrictions on how the money from a reverse mortgage can be used. This means the funds can be tapped to pay off debt, such as an outstanding mortgage, or take care of unexpected expenses.
- Loan proceeds are not taxable.
- There are no monthly mortgage payments.
- The homeowner can opt to receive the money in several ways, such as monthly payments, an emergency credit line, in a lump sum, or some combination of these.
- A homeowner can never borrow more than the value of the home. This means the heirs of the estate will never be held personally liable for more than what the home is sold for.
- Estate heirs inherit the home and keep any remaining equity on the property minus the balance of the reverse mortgage.
- The interest rate can be lower than that of a traditional mortgage or home equity loan.
Reverse Mortgage Cons
Perhaps one of the biggest problems with these products is that they are not so well understood. On one hand, some home owners may simply avoid these complex real estate products due to the many misconceptions that surround them. On the other hand, eligible retirees may jump in too quickly without fully considering how the loan will really affect them and their assets.
Here is a breakdown of the most significant cons of reverse mortgages:
- Reverse mortgages can get expensive. This is mostly due to an assortment of fees and various closing costs that are tacked on to the loan, such as a loan origination fee, mortgage insurance fee, appraisal fee, and title insurance fee that run higher than a traditional mortgage.
- If you permanently leave your home, you must repay the loan. This mostly is an issue for seniors who eventually need to enter a full-time care facility.
- Borrowers are still responsible for paying property taxes and homeowners insurance as well as maintain the home. If they fall behind on these expenses, they run the risk of foreclosing on the property.
- While a reverse mortgage typically does not affect eligibility for entitlement programs, such as Social Security or Medicare, some needs based government benefits such as Medicaid and Supplemental Security Income (SSI) may be affected.
- Finally, a reverse mortgage decreases the equity in the home. Unless, the amount borrowed was limited and the value of the property increases significantly, borrowers will leave less money to their heirs.
The key takeaway about reverse mortgages is that they have the potential to be a lifeline for some seniors in need of extra cash, but with few options to get the money they need. Yet, these products must be approached carefully.
Any seniors considering a reverse mortgage should consult a qualified financial advisor before making any commitments, since the long-term risks could outweigh any short-term benefits.
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