Is a Reverse Mortgage Right For You?

What Is a Reverse Mortgage?

A reverse mortgage is a non-recourse loan where you, the borrower, use your home as collateral. The lender pays you a set sum, and you have no monthly payments. However, that balance incurs interest and fees that grow over time. Eventually, you've got to pay it all back.

While terms can vary, all reverse mortgages require you to live in the home as your primary residence for the life of the loan. If you sell the house or move out, the entire balance must be paid back to the lender, including all the interest and fees. This means that terms and conditions are a priority among things you need to know before getting a reverse mortgage.

Reverse mortgages are marketed to retirees and older people to cover regular living and healthcare expenses. Most lenders and all government-sponsored reverse mortgage programs require borrowers to be at least 62 years old.

However, some lenders may permit you to take out a reverse mortgage as young as 55. You should also be aware that if your spouse is under 62, they cannot be listed as a co-borrower. But if the borrower passes away, a non-borrowing spouse can continue to live in the home following the same terms for maintenance and insurance that applied to the borrowing spouse.

Since a reverse mortgage will continue to grow until you pay it off, you need to be cautious about using this option if you do not anticipate paying it back in the short term or are concerned about how much your home's value will grow with time.

How Reverse Mortgages Work

Depending on credit eligibility and history, reverse mortgages are available to anyone with full home ownership. However, some homeowners who are still paying a primary mortgage may be eligible. Lenders will require you to maintain insurance on the home to protect their investment. Additionally, you are still responsible for paying any property taxes. 

The lender's goal with a reverse mortgage is for the balance to stay within the home's equity. Since younger homeowners are likely to continue living in the house for longer, lenders may limit how much they can borrow to protect against the balance due on the loan exceeding what can be secured by selling the home.

Payouts or loan disbursement vary depending on the type of reverse mortgage plan (see types of plans below). Repayment of the loan occurs when you sell the house or pass away. However, the lender is entitled to payment if you fail to maintain the property, live outside the home for at least a year, or stop paying the homeowners’ insurance or property tax. 

Types of Reverse Mortgage Plans

As you look to understand whether a reverse mortgage is right for you, you will come across a long list of ways to structure the payments and terms. What lenders offer will depend on your needs, credit history, and the lender's criteria, but there are a few basic categories that most reverse mortgages fall into:

• Tenure plan. If at least one borrower lives in the home as a principal residence, the tenure plan provides equal monthly payments that act as a regular income. Tenure plans are designed for retirees and older borrowers to pay living expenses. They are calculated as if you would live to the age of 100, dividing the total home equity into monthly payouts accordingly. 
• Term plan. Like tenure plans, term plans provide equal monthly payments based on the home equity you borrowed against. However, instead of making those payments for the rest of your life, they are only made for a set number of months or years. 
• Line of credit. The entirety of the loan is available as a credit line, up to the principal limit. As the borrower, you are free to access the money whenever you want in the amount you want. Borrowers only pay interest on what they receive.
• Modified tenure plan. This plan splits your approved total for your reverse mortgage into a portion dispersed as monthly payments and a portion you can access as a line of credit. Since the portion drawn against for monthly payments is smaller, the payments themselves will be smaller as well.
• Modified term plan. As with a modified tenure plan, the total approved loan amount is split between a term plan and a line of credit. The key difference is that while the smaller monthly payments are only paid out for the prescribed term, the line of credit remains available until exhausted, providing an additional source of funds after the term expires. 
• Fixed-rate lump-sum plan. You are paid in full for your home equity, with interest accrued until the loan becomes due and payable. This is recommended for paying off a high primary mortgage or other significant and imminent debt. 

Advantages of Reverse Mortgages

As you consider what you need to know before getting a reverse mortgage, there are many positives to consider. While it is not the right answer for everyone, here are several reasons why a reverse mortgage might be helpful: 

• Reverse mortgages are tax-free. The IRS considers reverse mortgage payments as loan payments, not income. Therefore, you won't pay taxes on them.  
• Borrowers make no monthly payments. While you or your heirs have to pay back the principal plus interest eventually, you will not have any payments for the life of the reverse mortgage.
• You can choose among flexible disbursement options. There are multiple different reverse mortgage plans, each with a unique disbursement that lets you receive payments the way you need. Some lenders also permit you to create hybrid plans tailored to your specific situation.
• Avoid the risk of borrowing more than you can pay back. A reverse mortgage is a non-recourse loan, meaning that you do not have to make up the difference if the house sells for less than the initial value. 

Disadvantages of Reverse Mortgages

So, is a reverse mortgage right for you? As you try to answer that question, you also need to remember some potential pitfalls you may encounter. The downsides of a reverse mortgage include the following:

• Reverse mortgages can be more costly than alternatives. Compared to other loans, reverse mortgages often use higher rates, leading to a higher overall cost for the borrower.
• You can't borrow against your home’s true equity. You will never receive the full value of your home equity from a reverse mortgage due to interest and fees counting against the value of your home. 
• Your home is no longer yours — unless you repay the loan. Reverse mortgages are meant to be repaid by transferring ownership of the property, which means you can’t leave your home to any heirs or use the home equity to settle other debts. 

What You Need to Know Before Getting a Reverse Mortgage

Understanding what you need to know before getting a reverse mortgage is critical in deciding on a lender. Many borrowers have no idea how these types of loans work, and so, unfortunately, the marketplace can be a ripe target for fraud and scams.

Even if a lender is legitimate, they may still use high-pressure tactics and suboptimal rates as a way to bolster their profits. Be sure to choose your lender carefully and look for one that will have your best interests in mind, such as your local credit union.

Another consideration is residency, as most reverse mortgages stipulate you must reside in the home. Absence for six months or more could complicate matters — even if the absence is unplanned, such as a hospital stay. To reduce the chance of this becoming an issue, you can have a co-signer on the reverse mortgage who also resides in the home.

When wondering, “Is a reverse mortgage right for you?” you also need to account for the additional fees that come with it. This includes an origination fee that usually adds several thousand dollars to the total cost of the loan, in addition to interest accumulating over time and any other periodic fees. Make sure to read the terms of your reverse mortgage contract carefully so you are not surprised by added costs.

Further Resources on Reverse Mortgages

We have examined much of what you need to know before getting a reverse mortgage. However, you can never be over-prepared when making a major financial decision involving your home, so here are a few more resources to consider:

• Make sure you explore all your options. You may be eligible for programs such as federally-insured reverse mortgages, so talk to several lenders and find what works best for you.
• Be on the lookout for fraud or predatory behavior. Scammers and predatory lenders are always adjusting tactics to find weaknesses within the market. Arm yourself with the knowledge to ensure you stay ahead of the risks.
• Know what you are getting into before you sign. Whether considering a reverse mortgage for your home or helping someone else, educating yourself on all the potential benefits and risks is important.

Make Your Reverse Mortgage Work for You

What is a reverse mortgage to you? Whether you’d like it to be the answer to supplementing your retirement savings, healthcare cost coverage, or simply a life preserver to keep you afloat in difficult times, look beyond a TV spokesperson espousing its benefits to find a lender that is as invested in your personal outcomes as they are in your loan. 

As community-based institutions, credit unions are deeply connected to the needs of their local members, and they typically have some of the best interest rates on the market. Check out our Credit Union Locator Tool to find a lender near you. 

Did You Know?

As member-owned not-for-profit financial institutions, credit unions can make informed decisions tailored to their community's requirements. Unlike large, national banks that may be more likely to follow a one-size-fits-all approach, community-based credit unions answer to the unique needs of their members — rather than profit-driven investors.