For a long time, reverse mortgages raised eyebrows among financial planners. But now, many consider these loans—which allow homeowners to tap their home equity and postpone repayment—as viable retirement tools.
Here’s what you need to know.
What’s a reverse mortgage?
This type of home loan is available to anyone 62 or older and allows you to withdraw some of your home equity without selling your house or taking out a line of credit. Your home equity serves as collateral, and, in return, you get fixed monthly payments, a lump sum or a line of credit—generally tax-free. You don’t have to pay your borrowed equity back for as long you as you live in the home.
You still must pay property taxes and make repairs to keep the house in good condition. If you can’t keep up the maintenance, you don’t keep homeowners insurance or you fail to pay property taxes, you can lose the home. The home also must be your primary residence. When you die, sell your home or move out, you or your heirs have several options to satisfy the reverse mortgage:
- Pay off the loan with your savings.
- Buy the house for 95% of its appraised value.
- Allow the lender to sell the home.
- Or sell the house and pay off the loan.
There are three types of reverse mortgages: single-purpose ones offered by state and local government and nonprofits, private reverse mortgages from lenders, and those insured by the federal government called Home Equity Conversion Mortgages (HECMs).
“The upfront costs of a reverse mortgage can be significant,” says Carl Holubowich, a certified financial planner at Armstrong, Fleming and Moore in Washington, D.C. Here’s what to expect.
Origination fee: Lenders can charge $2,500 or 2% of the first $200,000 of your home's value, plus 1% of the amount over $200,000, whichever is greater. Origination fees for the federally backed HECMs are capped at $6,000.
Mortgage insurance: Federally insured HECMs charge an upfront premium of 2%. You then pay an annual premium of 0.5% of the outstanding mortgage balance over the life of the loan.
Interest: Reverse mortgages can have fixed interest rates or variable ones, which track changes in a financial index. Each month, interest is added to the balance you owe. The interest is not tax-deductible until the reverse mortgage is paid off.
Third-party fees: You also have to pay other closing costs for an appraisal, title search, credit check, inspections, recording fees and mortgage taxes, among others.
When a reverse mortgage is a good idea
A reverse mortgage may be a smart—and possibly the only—financial move you can make if you’re woefully underfunded for retirement and need the extra cash flow. You also may consider a reverse mortgage to satisfy a debt that eats into your monthly income, or use it as a potential hedge if the economy turns.
A reverse mortgage may be useful if you:
- Have significant equity in your home
- Don’t mind selling your home in the future
- Plan to live in your home for at least five years
- And have a plan to fund housing after you sell your home
- Increase cash flow: You can use a reverse mortgage to pay off your traditional mortgage, freeing up the money that would normally go toward a monthly mortgage payment. “This is especially helpful if it lowers or allows you to delay making withdrawals from your portfolio,” says Holubowich, “allowing continued growth throughout retirement.”
Down markets: You can also open a line of credit through a reverse mortgage and tap your equity when you need it. In an economic downturn, you could pull funds from the line of credit rather than selling securities at a loss, says Holubowich.
When to avoid a reverse mortgage
There are good reasons to avoid a reverse mortgage, as well. For instance, you must live in the home if you have a reverse mortgage on it. If personal or health circumstances make that impossible, a reverse mortgage isn’t a viable solution, says Mary Ballin, a certified financial planner in Walnut Creek, California.
Another consideration is your family’s wishes. If it’s important to your spouse, children and grandchildren to keep the family home, a reverse mortgage may not be an appropriate financial decision. “Unless the heirs can pay (the reverse mortgage) back with other assets,” Ballin says, “they may not be able to keep the house.”