No one plans to struggle financially during retirement. For some, without a full-time job and healthcare benefits, covering basic living expenses and increased medical costs can be challenging. An investment portfolio and limited government benefits may not be enough to make ends meet.
You might consider a reverse mortgage as a way to supplement your income if you're retired and own a home. Commercials and other ads geared toward older adults present reverse mortgages as a low-risk way to receive your home's equity in one lump sum, monthly payments or as a line of credit — all without selling what may be your most valuable asset.
Before applying for a reverse mortgage, weigh the pros and cons of borrowing against your home during retirement.
What Is a Reverse Mortgage?
A reverse mortgage is a loan secured by your home where the lender makes payments to the homeowner based on the equity in the home. The most common reverse mortgage is a home equity conversion mortgage, or HECM, insured by the Federal Housing Administration (FHA). A HECM typically offers the best consumer protections and lowest borrowing cost.
Non-FHA-backed reverse mortgages, called proprietary reverse mortgages, are available through private companies and may cost more in fees. Some local government agencies and nonprofit organizations offer single-purpose reverse mortgages, which only fund specific expenses, such as home repairs or property taxes.
Generally, to be eligible, applicants must be at least 62 years old, live in the home as a primary residence, adhere to lender-defined borrowing limits, complete housing counseling and meet other lender requirements as part of the approval process. The loan is repaid when the home is sold, all borrowers die, or neither borrower can claim the property as their primary residence.
Pros of a Reverse Mortgage
A predictable source of income during retirement isn't the only reason retired homeowners consider applying for a reverse mortgage. A HECM may offer additional benefits, such as:
- Tax Benefits
Reverse mortgage payments aren't taxed as income on federal tax returns, so won't affect Medicare or Social Security benefits. But if individuals receive Medicaid or Supplemental Security Income (SSI), reverse mortgage proceeds could be impacted as each state has eligibility limits based on assets and income. Before you consider a reverse mortgage, discuss the laws of your state and individual finances with a tax advisor.
- Depreciation Protection
A decrease in a home's value is unlikely to negatively affect the owner's finances since they'll never owe more on the property than its fair market value. If the home sells for more than the balance owed, the owner or heirs get to keep the difference. However, if the home's value falls below the amount owed, the lender will accept 95% of the home's appraised value or the full loan balance, whichever amount is less.
- Potential for Lifelong Payments
Even if the home isn't owned home outright, there may be enough equity to receive lifelong payments as long as the owner lives in the home as their primary residence.
- Repayment Flexibility
Unlike loans that require repayment shortly after disbursement, reverse mortgages only require repayment if the home sells, no longer serves as the primary residence, or when the owner passes away.
Non-FHA-backed reverse mortgages may offer additional or fewer benefits.
Cons of a Reverse Mortgage
Reverse mortgages do come with drawbacks, depending on an individual's financial situation and long-term goals. Disadvantages might include:
- Potential Inheritance Issues
Passing down a generational home might be included in an estate plan. But if the estate can't repay the loan when the owner dies, the heirs may need to sell the home instead of keeping it in the family.
- Continued Homeownership Expenses
Keep in mind that even with a reverse mortgage, borrowers are still responsible for the ongoing costs of homeownership. If you don't keep expenses like routine home maintenance and repairs, property tax payments, and homeowner insurance premiums in your budget, it could cause the lender to consider the reverse mortgage to be in default or indicate other financial problems.
- Monthly payments
Taking the reverse mortgage proceeds in monthly payments will increase the loan balance over time.
- If a homeowner moves into a long-term care facility or lives elsewhere for 12 consecutive months for medical reasons, they can no longer claim the home as their primary residence. This also means the entire loan balance is due at that time, instead of when they pass away. If there is a surviving spouse, they can legally remain in the home as long as they pay property taxes and homeowners insurance. However, they won't be able to continue borrowing money through the reverse mortgage.
- Reverse mortgages aren't interest-free loans. They come with a fixed or variable interest rate that increases the total amount repaid over the life of the loan. Other expenses, such as origination fees and closing costs, can be rolled into the borrowed amount. However, doing so will reduce the cash received.
Reverse Mortgage Alternatives
There are other ways to generate income from a home during retirement. Renting designated spaces on your property could provide a steady stream of cash without going into debt. Some options include:
- Rooms for vacation travelers.
- Parking space for special events.
- Your swimming pool for parties.
- Extra storage space for specialty vehicles, business inventory, etc.
Online rental marketplaces exist that connect owners with renters. Search online to learn more about each one. Keep in mind, local ordinances may have restrictions on the use of your home for commercial purposes, and there could be limitations in your homeowner insurance policy that may not cover losses from commercial use.
The Bottom Line
Reverse mortgages are a financial tool to help many overcome money issues during retirement. Loan costs and various restrictions may conflict with your plans. Retired homeowners should consider other non-debt alternatives for generating income before deciding a reverse mortgage is the right move for their finances.
Financial Counseling Can Help
SchoolsFirst FCU has partnered with GreenPath Financial Wellness to help you develop a financial strategy and save for retirement. If you want to learn more about the pros and cons of reverse mortgages, schedule a complimentary consultation with a financial coach today.
Discuss Home Loans With Our Experts
SchoolsFirst FCU doesn't offer reverse mortgages. Learn more about our home loan options. Our consultants will be happy to discuss one that may be right for you.