If you own a home and have reached retirement age, you may be able to turn your home into a source of income. While a traditional mortgage loan requires a monthly mortgage payment from the borrower, a reverse mortgage does the opposite. With a reverse mortgage, the bank pays the borrower every month, offering a method of tapping into the home’s equity without selling.
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.
Key Takeaways
- A reverse mortgage loan offers a payment to the borrower every month.
- Like a traditional mortgage, the loan accrues interest and incurs fees.
- Your heirs are typically required to pay off the loan if they want to keep your home after you’re gone.
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.
note
You typically don’t have to repay your reverse mortgage as long as you live in the same house. Proceeds from selling the house may be used to repay the loan if you decide to move or after your death.
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.
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The amount you receive every month will vary depending on your home’s value, credit history, lender, market interest rates, and other details. Also, keep in mind that these loans require upfront fees that can reach thousands of dollars.
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, which is always 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.
Frequently Asked Questions (FAQs)
How do you pay back a reverse mortgage?
A reverse mortgage is paid off by selling the home in most cases. As a secured loan, the lender has the right to be repaid from the proceeds, and you can keep anything leftover. If you have a reverse mortgage and pass away, your heirs can repay the loan using the loan’s proceeds, or find other means to repay the balance if they want to keep the home.
Who owns the house in a reverse mortgage?
With a HECM loan or reverse mortgage, the borrower retains the title to the home. That’s a fancy way of saying that the borrower who lives in the home is also the owner. When you move out, sell the home, or the last surviving person listed on the loan passes away, the bank can seek repayment.
When is a reverse mortgage a good idea?
A reverse mortgage may be a good idea in some situations, but it isn’t for everyone. If you’re not sure if a reverse mortgage is a good choice for your finances, consider working with an approved reverse mortgage counselor. The US Department of Housing and Urban Development (HUD) offers information on finding an approved counselor at 800-569-4287 or online at HUD.gov.
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