There are many factors to consider when figuring out if a reverse mortgage is right for you, so it is important that you understand all of the possible benefits and pitfalls, so we’ve listed the most common pros and cons below.
Pros of a Reverse Mortgage
For some homeowners, a reverse mortgage can provide many benefits with little downside. Here are the primary reasons most people take out this type of loan.
When you look at the alternatives to a reverse mortgage, what other options keep you in your home? The vast majority of homeowners surveyed mentioned that they want to remain in their home for as long as possible. Using the equity to stay in your home, keep it attractive to you, and keep up your quality of life are all important features.
2) No Monthly Principal Or Interest Payments
Have you ever been able to borrow money in the past without having a monthly principal or interest payment? The reverse mortgage is a safe way of accessing the equity in your home, because you only have to pay the taxes and insurance every year. There is a lower risk of foreclosure when compared to a conventional loan or HELOC. That’s definitely a positive when you have a limited, fixed income.
3) Qualifying May Be Easier
Qualifying for a reverse mortgage may be easier than qualifying for a conventional mortgage. Conventional mortgages require you to have a certain credit score and debt to income ratios. Reverse mortgage qualifying is based on credit history and a residual income test (read here for more details).
4) Flexible & Tax-free Proceeds
You have the option to receive your proceeds in a variety of ways that can fit most needs, whether they are in a lump sum, line of credit, monthly payments, or a combination of those options. The equity in your home is available to you tax-free, because it isn’t considered income, but instead loan proceeds. Compare that feature with potential early withdrawal penalties of your other assets.
A very positive feature of all FHA reverse mortgages is that they are non-recourse in nature. The only collateral used in the transaction is your home. Should it ever be sold for less than is owed to the lender, the FHA mortgage insurance fund will cover the loss. Should you take out a reverse mortgage, you can rest assured that your heirs will never owe more than the house is worth.
Cons of a Reverse Mortgage
As with many financial instruments, a reverse mortgage may not be the best choice for all individuals. Below the most commonly cited cons of a reverse mortgage, though there are other disadvantages to be aware of too.
If you are leaning towards taking a reverse mortgage with a line of credit or monthly payments (i.e. the adjustable rate product), you will have substantial closing costs. One of the major costs, for those drawing 60% or more of the loan amount, is the upfront FHA mortgage insurance premium. The other negative in the cost column is the compounding interest accrual.
Should the equity in your home be used freely or only as a last resort? That’s a very personal question that an outsider shouldn’t attempt to answer for you. If you use it now, and for good reasons, you obviously won’t have it later in life, should you have to sell and move elsewhere.
There’s an obvious downside to taking out a reverse mortgage if you intend to leave the home free and clear to your heirs. You would be borrowing a large portion of the equity, and in some cases all of the equity, leaving your family with little in the way of inheritance. We suggest having a conversation with your loved ones to clear the air on inheritance expectations vs. current quality of life.
4) Interference with Benefits
Be very aware of how your Federal, State, County, and/or City benefits are calculated. Consider what will happen to them if you are to receive funds from a reverse mortgage. More importantly, speak with a professional that is intimately familiar with the laws to make sure you are making the right decision.
5) Mortgage Interest Deduction
You can only deduct mortgage interest in the year in which you paid it. Reverse mortgage interest is deferred, and typically only paid when the loan is paid off. The annual mortgage interest deduction that one might desire is less likely to make sense with this product.
Consult a Specialist
While we offer extensive resources to make sure you have all the information, it is always best to consult with a reverse mortgage professional before applying for the loan so that you can understand the reverse mortgage pros and cons in full. You want to ensure that there are no major surprises during the process.