Reverse mortgage loans allow seniors to pull equity out of their homes in the form of a cash loan. These loans have many benefits, such as giving seniors access to needed money, and drawbacks, such as spending the equity in something that’s commonly considered part of a senior’s estate, to be inherited.
In a reverse mortgage, the lending bank pays the borrower money that comes from the home’s equity. At the end of the loan, the borrower or the borrower’s heirs pay back the principal and interest in full.
For seniors living on a fixed income who have spent much of their lives building up equity in a home, a reverse mortgage provides access to cash that they may need for their current living expenses. Before deciding to take one out, seniors should weigh the pros and cons to determine if this is the right financial choice for their estates and beneficiaries. This guide will explore what a reverse mortgage is, discuss its pros and cons and answer some of the frequently asked questions about this financing option.
How Do Reverse Mortgages Work?
In a conventional mortgage, the borrower makes a monthly payment. Part of that payment goes toward the principal balance of the loan, and the other part goes toward interest.
In a reverse mortgage, the borrower takes out a loan for an agreed-upon amount based on the equity in the property. Instead of making a monthly payment divided between interest and principal, the borrower receives a payment for the principal portion. The interest portion is added to the loan’s balance.
This provides cash that the borrower can use however desired. The payments are typically made monthly, but they can be paid in one lump sum or used as a line of credit, depending on how the borrower and lender structure the loan.
When the borrower is ready to sell the home, passes away or moves out of the home, the balance of the loan, plus any accrued interest, must be repaid in full by either refinancing or selling the home.
What Are the Pros of Reverse Mortgages?
Seniors can benefit from reverse mortgages in several ways, including:
Added Cash Flow
Reverse mortgages provide a way to add cash flow to a senior’s budget. Seniors who still owe on their mortgages can refinance to a reverse mortgage and eliminate their biggest expense while pulling some money from the home loan. Seniors who own their homes in full can use that equity to give them more cash for their day-to-day expenses.
Ability to Age in Place
With a reverse mortgage, a senior can age in place more easily. The loan can make room in the budget to help seniors afford their homes longer.
Lower Costs Than Moving
The costs of a reverse mortgage are often less than the costs of moving. Seniors won’t need to prepare the home for sale, hire an agent to sell it or pay for the cost of moving their belongings to a new home.
Tax Savings
Money from a reverse mortgage is not taxable. The IRS views it as a loan, and, therefore, the income doesn’t get taxed like regular income.
Remain in Ownership of the Home
Reverse mortgages are typically paid off when the borrower or the borrower’s estate sells the home, but the borrower doesn’t lose ownership of the home while enjoying the perks of the loan.
What Are the Cons of Reverse Mortgages?
Reverse mortgages have some drawbacks to consider before applying for one. These include:
Cost of Reverse Mortgages
Reverse mortgages are refinance loans. Borrowers pay closing costs and lender fees, which can be rolled into the loan balance. This adds to the debt and reduces equity.
Interest Charges
Though the borrower doesn’t pay interest charges directly month to month, interest accrues in the loan’s principal balance. In the end, the estate’s heirs have to pay these charges.
Effect on Medicaid and SSI Programs
Seniors who qualify for Medicaid or SSI programs may find that their reverse mortgage payments impact their asset restrictions. Discussing this with a legal professional is helpful in understanding the potential impact.
Potential for Foreclosure
Though the bank isn’t requiring the borrower to make monthly payments for the loan, foreclosure can still happen. If the senior doesn’t pay property taxes or maintain their insurance payments, the bank can foreclose on the home to cover these bills.
Spending Inheritance
Many people view the family home as part of their legacy for their heirs. A reverse mortgage means spending part of that inheritance while still living.
Frequently Asked Questions About Reverse Mortgages
Can the estate’s heirs end up owing more than the home is worth?
Even though the principal on the loan grows each month, the total mortgage debt on reverse mortgages can’t exceed the property’s fair market value. This means the lenders can’t issue claims against the estate or its heirs. If the debt is more than the property is worth, the heirs simply give the title back to the lender and move on, but they don’t have to pay the difference.
How much equity can a senior take through a reverse mortgage?
This varies from one lender to the next, but they generally offer 40 to 70% of the home’s appraised value. The borrower’s age also impacts how much the lender is willing to lend in a reverse mortgage.
When does the borrower have to pay off the reverse mortgage?
The reverse mortgage comes due when the borrower sells the home or no longer lives in it as a primary residence for 12 months or more. This typically occurs when the borrower dies, moves or relocates into a care facility. The loan also comes due if the borrower doesn’t pay property taxes and homeowners insurance on time. If the borrower passes away, the heirs have approximately six months to refinance or sell the home.
Does a reverse mortgage require the borrower to own the home free and clear?
No, as long as there is sufficient equity in the home to meet the lender’s loan-to-value ratios, a reverse mortgage is possible. However, lenders don’t allow reverse mortgages to stand with an existing lien. To use a reverse mortgage on a home that isn’t paid in full, the borrower must refinance, paying off the existing loan at the closing for the reverse mortgage loan.
