While the recent recession has not spared any age group, it has been particularly difficult for older Americans who may have been counting on their fixed income to last through their retirement years. To supplement cash flow during retirement, a growing number of senior homeowners are turning to an increasingly popular financial tool called a reverse mortgage. Over one million borrowers have used this home equity loan created specifically for seniors’ unique needs. And while reverse mortgages help many, they may not be right for everyone. Educating yourself about the details of the loan, including the advantages and the disadvantages, can help you decide if a reverse mortgage is a good option for you.
What Is A Reverse Mortgage?
A Home Equity Conversion Mortgage, also known as the HECM reverse mortgage, is a loan that functions as a federally-insured cash advance on a borrower’s home equity, and, while there are other maturity events as well, it is repaid when the last borrower or eligible non-borrowing spouse leaves the home. They are essentially home loans for homeowners ages 62 and older, and like any loan, there are pros and cons of reverse mortgages.
Reverse Mortgage Cons
Because reverse mortgages are designed with many beneficial features, including no monthly mortgage payment and government insurance, senior homeowners are keenly attracted to them. However, like all financial products, there are aspects of this loan that may not best serve your specific situation. The following are a few important considerations to note. Borrowers remain responsible for paying property taxes, homeowner’s insurance, and for home maintenance
Con: The federal government regulates reverse mortgages.
As with any loan, to ensure the highest quality of consumer safety, HECM reverse mortgages are strictly regulated by the federal government. Although this is often regarded by borrowers as a positive aspect of the loan, some do not like the fact that these regulations increase the number of requirements borrowers must meet in order to qualify. However, strict regulation means that safeguards are continually being implemented and developed to ultimately benefit borrowers.
Con: You must have enough equity in your home.
Reverse mortgages were designed to help you to access the untapped wealth sitting in your home in the form of equity. Pulling this wealth from the home, converting it into cash, and using it to supplement your cash flow in retirement can be an intelligent and financially strategic move for many seniors. Therefore, another area of consideration is that you must have enough equity in the home in order to qualify. This can be a drawback for some seniors who have a low amount of equity, because even though these borrowers may pay off their existing mortgage, they may not have enough disposable loan proceeds to achieve their financial goals. There are a few reasons why this requirement is in place:
- A requirement of the loan is that any existing mortgage is paid off first so that the reverse mortgage is the only lien on the home. Funds from the reverse mortgage are used to pay off the liens first, so there needs to be at least enough equity to cover this amount.
- The Loan to Value (LTV) ratio of the home needs to meet the guidelines determined by the U.S. Department of Housing and Urban Development (HUD) in order to qualify for a reverse mortgage loan. Since these loans don’t require a monthly mortgage payment, this guideline calculation takes into account your existing mortgage, any interest and fees that will be added to the loan balance, and the life expectancy of the loan. Borrowers remain responsible for paying property taxes, homeowner’s insurance, and home maintenance.
If you have built up enough equity in your primary residence, you may tap a portion of the home’s equity in cash proceeds that you can use in almost any way you would like.
Con: Not all properties will qualify.
Reverse mortgages were designed with the intention of helping senior homeowners age in place and enjoy retirement in the home they love. Therefore, vacation homes and investment homes are not eligible. Only the primary residence qualifies for this loan.
Other kinds of properties may not be eligible for a reverse mortgage, including homes that are not FHA approved, mobile homes, and certain condominiums. If you want to learn more about this topic, we recommend you read this article on qualification requirements for reverse mortgage loans.
Con: A reverse mortgage is secured by placing a lien on the home.
When a borrower takes out any type of home equity or mortgage loan, a lien is placed on the home as collateral. Although this is no different with a reverse mortgage, it may still be seen as a downside for borrowers who prefer owning a home that is completely paid off. However, one advantage is that your other assets are protected in the event of a foreclosure, and only your home may be used to pay for the debt. This is due to the government-mandated non-recourse feature of all HECM reverse mortgage loans.
Con: You must keep the home insured and maintained, as well as pay taxes in order to avoid foreclosure.
Because loan repayment is usually covered by the sale of the home at the end of the loan term, the home must be kept in good condition so it can sell for a price that is at least equal to the amount of your loan balance. Therefore, it is the borrower’s responsibility to keep the home maintained with basic repairs, as well as ensure the home is protected by homeowner’s insurance, just as you would need to with a traditional mortgage loan.
In addition, since monthly mortgage payments are not required, failing to keep up with your regular homeowner responsibilities of paying property taxes could cause your loan to become due and payable. While this is a normal expense, it may be an important factor in making a decision; especially if you are currently struggling to pay your property taxes.
The good news is, if this is the case for you, then your reverse mortgage lender can arrange to set aside some of your loan proceeds to pay these recurring expenses so you can still get the loan and meet your financial obligations.
Reverse Mortgage Pros
The reverse mortgage loan has proven to be a helpful financial tool for many senior homeowners in retirement due to the following features.
Pro: No monthly mortgage payments are required on the loan.
With most mortgage loans, some form of monthly repayment is required, which means that a portion of your income every month must be allocated towards this expense. With a reverse mortgage, you do not have to make any monthly mortgage payments on the loan. Instead, repayment is deferred until you move out of the house, pass away, default on loan terms, or sell the home. Borrowers remain responsible for paying property taxes, homeowner’s insurance, and for home maintenance. This is beneficial because the amount that would have been spent on housing can be allocated towards other expenses, placed in savings, or invested.
Pro: Loan proceeds are non-taxable.
One of the most popular aspects for senior homeowners is that any funds you receive from your reverse mortgage are recognized as loan proceeds and not income. This means your loan proceeds are not taxed. Some retirement investments are taxed as you draw from those accounts, so having a source of money that does not have this restriction may be a breath of fresh air to you.
Pro: You can continue to live in your home for as long as you wish, as long as you meet your loan terms.
As mentioned above, the main goal of a reverse mortgage is to help seniors stay in their homes. The terms of the loan require that certain responsibilities are met to avoid foreclosure, and as long as you follow those terms, you may live in your home and receive the funds from your equity without paying a monthly mortgage payment. Borrowers do remain responsible for paying property taxes, homeowner’s insurance, and for home maintenance.
Pro: You remain the owner and keep the title.
One common misconception about reverse mortgages is that borrowers are selling their home to the lender. This is simply not true. Reverse mortgage borrowers continue to own the home and retain title to the property, subject to a lien as with most other mortgage loans. However, in the event that the aforementioned loan obligations are not met, then the home may go into foreclosure, just as it would with any type of mortgage.
Pro: You are protected from owing more than the value of the home when sold at loan maturity.
Due to the federal insurance protection offered by the FHA, you do not have to pay more than the value of the home when it is sold, even if your loan balance surpasses your home’s value. This is important because it eliminates the worry that you or your heirs may be left with additional debt from the reverse mortgage after the home is sold.
Pro: The loan is non-recourse, so all your other assets are protected.
Since a HECM reverse mortgage is a non-recourse loan and it is secured by placing a lien on your home, you are protected from having any of your other assets taken as repayment for the loan. The home is the only asset that a lender may utilize in order to pay the loan back; anything else is off-limits.
Pro: Government regulations allow you to make informed decisions and protect you from default.
The government-insured HECM reverse mortgage is known to be well-regulated and designed with the highest standard of consumer safety in mind. For example, all applicants must complete a mandatory counseling session with an approved third-party reverse mortgage counselor.
This is important because these FHA-approved counselors are knowledgeable about a number of financial options, and can advise you of other available routes that you may not have considered before. However, if you are confident a reverse mortgage loan is the best option for you, these counselors can answer your questions and offer unbiased information about the advantages, drawbacks, loan process, and your responsibilities as a borrower.
FHA-approved counseling is not the only government regulation that can safeguard you as a consumer. Other regulations include a limitation on lender origination fees, and a financial assessment to evaluate your ability to fulfill loan obligations such as the payment of property taxes and regular upkeep of your home.
Pro: You can still make payments on the loan without any pre-payment penalties.
Although monthly repayments are not required, you will incur no additional costs if you choose to repay your loan during the term. If you prefer to repay the loan in part or in full, you may do so at any time without penalty. While some seniors continue to make payments on their loan in the same manner as they would with a traditional mortgage in order to keep their balance low, they feel secure knowing that they could skip those payments if needed.
These are just a few pros and cons of reverse mortgage for seniors ages 62 years and older to consider, and many senior homeowners agree that the positives outweigh the negatives when comparing them. To learn more about the details of the pros and cons of reverse mortgages, speak with a reverse mortgage professional from American Advisors Group at 1-800-224-9121 or click here to request a free reverse mortgage info kit. All consultations are free and can provide a wealth of information to help determine if a reverse mortgage loan can be beneficial to you.