Key takeaways
- If you're a homeowner aged 62 or older, a reverse mortgage can help you obtain tax-free income, allowing you to stay in your home, pay bills, supplement your income and more.
- A reverse mortgage isn't free money: The borrowing costs can be high, and you’ll still need to pay for homeowners insurance and property taxes.
- Reverse mortgages can also complicate life for your heirs, especially if they don’t want the home or the home’s value isn’t enough to cover what’s owed.
If you watch TV, you’ve likely seen Tom Selleck and Henry Winkler touting reverse mortgages as a valuable income source for anyone retired or with limited funds. These types of loans can be worth getting, but they aren’t for everyone. Here are the pros and cons.
Reverse mortgage pros
You can better manage expenses in retirement
Many seniors experience a significant income reduction when they retire. A reverse mortgage allows you to supplement that diminished income without digging into savings. You don’t have to make monthly payments, either, which could help free up room in your monthly budget.
You don’t have to move
Instead of leaving your home, a reverse mortgage allows you to age in place. Additionally, while a reverse mortgage comes with fees and other costs, it might cost less in the long run than buying another home or renting in a new location.
You don’t have to pay taxes on the income
The money you get from a reverse mortgage isn’t taxable because the IRS considers it “loan proceeds,” not income. (However, it could be considered income by other agencies — more on that below.)
You’re protected if the balance exceeds your home’s value
Because a reverse mortgage balance grows over time, it’s possible that what you owe can eventually exceed your home’s value. However, because a reverse mortgage is what’s known as “non-recourse” financing, the amount of debt that must be repaid can never exceed the property’s value. That also means the lender can’t make any claims against your other assets or those of your heirs.
Your heirs have options
A borrower can pay off their reverse mortgage at any time, but typically, repayment doesn’t happen until it’s required: when the borrower moves, sells the home or passes away. In an estate situation, this leaves heirs with potentially several choices:
- Sell the property to repay the debt and keep any equity above the loan balance
- Repay the debt out of pocket
- Keep the property and refinance the reverse mortgage balance if the property’s value is sufficient
- Allow the lender to assume the property’s title if the debt exceeds the property’s value (or the heirs simply don’t want the house)
That last option allows the lender to file a claim for any unpaid balance with the insurer (almost always the Federal Housing Administration, or FHA, which oversees the Home Equity Conversion Mortgages, or HECMs, the most popular type of reverse mortgage).
Reverse mortgage cons
You have to pay fees
Reverse mortgages come with fees, including:
- Origination fee (capped at $6,000 for HECMs)
- Mortgage insurance premiums (MIP)
- Closing costs from third parties, such as an appraisal fee or recording fee
- Monthly servicing fee up to $35
Many of these expenses can be rolled into the loan principal; however, that can substantially increase the amount you owe.
You can’t deduct the interest until you repay
You might have enjoyed the mortgage interest deduction on your taxes when you were paying off your mortgage, but you won’t be able to deduct the interest on a reverse mortgage each year. You’ll only enjoy that perk when the loan is paid in full.
You could inadvertently violate other program requirements
A reverse mortgage could cause you to violate asset or income restrictions for the Medicaid and Supplemental Security Income (SSI) programs. This might affect your eligibility for these benefits.
You still have home-related expenses
A reverse mortgage doesn’t let you off the hook for property taxes, homeowners insurance premiums and HOA fees. If you fail to pay any of these expenses in a timely manner, that violates the reverse mortgage agreement and your home could be foreclosed.
Your survivors might run into issues
When the borrower is no longer living in the home, the reverse mortgage either has to be repaid in full or the home surrendered to the lender. This scenario could be triggered by death, but also by moving to a nursing home or long-term care facility.
This situation can cause complications for those non-borrowers still living in the home. While there are protections in place for surviving spouses, they only apply if you were married prior to obtaining the reverse mortgage.
The amount to repay could be a lot larger than you anticipated, too. If you never or only minimally repaid the balance before the triggering event, it might be all the more challenging to repay now.
Who is a good candidate for a reverse mortgage?
With all the potential complexities and risk, is a reverse mortgage a good idea? For some homeowners, the answer might be yes if:
- You anticipate staying in your home for a long time – Since you’ll pay another set of closing costs with a reverse mortgage, ideally, you’ll want to stay in the home long enough to break even on the expense. If you’re 62 and expect your current place to remain your forever home, a reverse mortgage could make sense.
- You need more money to manage everyday expenses – If you’re struggling on a limited income, a reverse mortgage can help you keep up with some bills.
- Your home is increasing in value – If you live in a market where home values are appreciating, your property might be worth more by the time you or your heirs pay back the loan.
If you’re a senior having a hard time paying bills, many states and local utilities and organizations offer help. AARP maintains a list of benefit programs by state.
Who is a bad candidate for a reverse mortgage?
Here are a few signs that a reverse mortgage isn’t right for you:
- You’re planning to move – Remember: You’ll want a long runway to make paying all the closing costs, mortgage insurance premiums and other fees worth it.
- You might need to move due to health issues – A reverse mortgage requires you to live in the home, which means that relocating to a nursing home or any kind of assisted living arrangement could result in needing to pay back the loan in full.
- You’re struggling to cover other home-related costs – If you’re challenged coming up with the cash for property taxes and homeowners insurance, it’s best to avoid a reverse mortgage. You’ll need to keep paying these expenses to meet the requirements for the loan.
Should you get a reverse mortgage?
Reverse mortgages have gained a reputation thanks to some scams that target unsuspecting seniors. Even legitimate companies have used dishonest marketing to try to get homeowners to take out reverse mortgages. The simple rule is: Be very cautious about putting your home at risk.
Still, there’s at least one key reason you might consider a reverse mortgage: elevated equity. Over the past few years, home values have grown, giving many homeowners a much bigger opportunity to tap their equity.
Remember that you have other options to access cash, too. Compare a home equity loan versus a reverse mortgage to see which one might be a better fit for your needs.
