The Home Equity Conversion Mortgage (HECM), commonly known as a reverse mortgage, is a federally-backed loan. It is a legitimate financial product designed to allow older homeowners a way to access the equity in their homes without monthly mortgage payments. Unfortunately, that doesn’t stop scammers from trying to take advantage of vulnerable Americans.
The truth is that a reverse mortgage isn’t right for everyone, but for those who are facing specific challenges or who have certain needs, it may be the solution they’ve been looking for to help increase cash flow in retirement.
In this article, we will discuss when a reverse mortgage is a good idea and when it isn’t.
Let’s dive in.
A Reverse Mortgage Explained
Before discussing whether or not a reverse mortgage is a good idea, we first need to know what it is.
A HECM reverse mortgage is the most common type of reverse mortgage. It is a type of home loan available only to homeowners who are 62 years of age or older and have significant equity in their homes. The home must also be the homeowner’s primary residence and in good condition. Reverse mortgages cannot be obtained for a vacation home or investment property.
It provides a way for homeowners to tap into their equity without having to take on additional monthly mortgage payments. When a homeowner takes out a reverse mortgage loan, it pays off the current traditional mortgage.
The home still belongs to the borrowers, not the bank, which means that homeowners are still required to pay property taxes, homeowners insurance, and maintain the home.
For any remaining equity, borrowers have the option of receiving their funds as a lump sum payment, monthly payments, a line of credit, or a combination of the three.
The amount of money that a reverse mortgage borrower can receive is based on the age of the youngest borrower, the home’s value, and the current interest rate.
There are no limitations on how the reverse mortgage proceeds can or can’t be used. Some common uses of reverse mortgage funds include supplementing monthly income, funding major home projects such as home improvements and renovations, paying off credit card debt and personal loans, and as a backup source of funds to cover unplanned expenses.
A reverse mortgage may also be used to purchase a new home. This is known as a reverse mortgage for purchase or HECM for Purchase.
A reverse mortgage is paid back when the homeowner decides to sell, the home is no longer the homeowner’s primary residence, or the homeowner passes away.
A HECM reverse mortgage is regulated by the U.S. Department of Housing and Urban Development (HUD) and insured by the Federal Housing Administration (FHA).
When is a Reverse Mortgage a Good Idea
Reverse mortgages used to be viewed as a last resort to pursue when retired homeowners needed additional cash, but this is no longer the case, The New York Times said in a report in 2022.
A reverse mortgage is now seen as a potential solution for a variety of needs and situations, including the following:
- When you plan to retire in place. A reverse mortgage makes it easier for those heading into retirement to be able to retire in place. While retirement communities abound throughout the country in states such as Florida, Arizona, and elsewhere, a study from the Center for Retirement Research found that most retired Americans stay in the same homes where they lived in their early 50s.
- When you need to supplement your income. If homeowners find that Social Security payments and other sources of retirement income aren’t enough to meet their financial needs, they may look for other ways to supplement their income. Many older homeowners have a large share of their wealth tied up in their homes. According to the Center for Retirement Research, “Home equity is the largest store of savings for most households entering retirement.” A reverse mortgage is a type of home loan that is uniquely designed for those in their golden years to access that equity.
- When you need added protection. A study conducted every three years by the Federal Reserve found that most Americans are not saving enough for retirement. The study found that Americans from age 55 to 64 have a median retirement savings of $134,000. While this is a decent amount of money, it’s not enough to cover all the expected costs in retirement. For those who find themselves in this situation, a reverse mortgage may be the solution they need to offset costs.
- Preserve savings and cash reserves. Some Americans are starting to turn to reverse mortgages as a way to preserve their savings and cash reserves. Virginia woman Marjorie Fox told The New York Times that she decided to take out a reverse mortgage for exactly this reason — she wanted to prepare for the unexpected, so she decided to receive her reverse mortgage funds as a line of credit.
- Protect investment portfolios. The stock market goes up and down, which affects 401(k)s and other investments. If the stock market takes a downturn when it’s time to retire, a homeowner could use a reverse mortgage to supplement their income while they wait for the market to recover before they pull out their investments.
- Delay claiming Social Security benefits. Social Security benefits go up a small percentage for each month retirees delay claiming their benefits. A reverse mortgage could be used to supplement income until Social Security beneficiaries are ready to claim their benefits. Homeowners can take out a reverse mortgage at age 62. However, they can delay taking Social Security benefits until age 70.
- Pay large medical bills and credit card debt. For Americans heading into retirement with a large amount of credit card debt or medical bills, a reverse mortgage could also be used to pay off this debt.
There are other ways to access your equity without taking out a reverse mortgage, such as a Home Equity Loan, a Home Equity Line of Credit (HELOC), cash-out refinancing, or selling the home.
However, a home equity loan, a HELOC, and a cash-out refi will all require monthly payments to pay them back, which can be difficult in retirement, especially if the homeowners are living on a fixed income. One of the reasons a reverse mortgage works so well for those in retirement is that it is not paid back with monthly payments.
Watch the video below to learn how a reverse mortgage can help protect your retirement savings, especially during a bear market.
When a Reverse Mortgage is Not a Good Idea
While there are times in which a reverse mortgage is a good idea, this is not the case for everyone.
Here are some situations in which a reverse mortgage may not be the right choice:
- If you plan to move. While a reverse mortgage can be used to purchase a new home, it may not be best to get a reverse mortgage on your current home if you plan to move soon. Reverse mortgages are typically recommended for those who expect to stay in their homes for at least five years.
- If you want to leave your home to your children. You can still leave a home with a reverse mortgage to your family, but because a reverse mortgage uses up a large portion of your equity, it may make it more difficult for your children or heirs to keep your home after you pass away. After you pass, your heirs will be given the option to sell the home and keep the proceeds or keep the home. The good news is that a reverse mortgage is a non-recourse loan, which means they will never owe more than the loan balance or the home’s value, whichever is less, according to HUD.
- If you can’t afford to maintain the home and other costs. Reverse mortgage borrowers are still required to pay the property taxes, the homeowner’s insurance, any dues such as HOA fees, and home maintenance costs. While a reverse mortgage can offset these costs, if you think you will struggle to cover these costs, then a reverse mortgage may not be the way to go. Most reverse mortgage lenders will assess your financial health to make sure you are able to meet all reverse mortgage requirements before moving forward with the application.
Reverse Mortgage Protections
Because there are scammers out there, the federal government has established several added protections to give reverse mortgage borrowers additional peace of mind. Some of those protections include the following:
- Third-party counseling. Before homeowners can submit an application for a reverse mortgage, they must first complete a counseling session with a third-party counselor who is approved by HUD. The counselor will ensure that potential borrowers understand what a reverse mortgage is, how it works, as well as potential alternatives. This is an added layer of protection to make sure that homeowners understand the product and do not fall prey to would-be scammers.
- Non-recourse loan. A HECM reverse mortgage is a non-recourse loan. This means that you will never owe more than what the home is worth or the value of the home, whichever is lower. This protects homeowners if the housing market is in a decline, and the loan is more than the home’s market value.
- Right to cancel. Homeowners have the right to cancel a reverse mortgage at any time during the application process including three business days after signing closing documents.
- First-year principal limit. When homeowners take out a reverse mortgage as a lump sum, they may only take out 60 percent of the loan amount during the first year. This is to ensure that your money lasts longer.
- Non-borrowing spouses. There are also protections for non-borrowing spouses in the event that the borrower leaves the home for more than 12 months. This may happen if he or she goes to live in a long-term healthcare facility or the borrower passes away while the non-borrowing spouse is still living in the home.
The Bottom Line
Taking out a reverse mortgage loan is a major decision.
A reverse mortgage is a financial tool that can provide a financial lifeline in retirement. It enables individuals to supplement income, manage unexpected expenses, or even delay Social Security benefits for a more favorable payout.
However, the decision to pursue a reverse mortgage should not be taken lightly. It is not a one-size-fits-all solution and may not be suitable for everyone.
It is always recommended that you discuss any major financial decisions with your financial advisor and family members who may be affected.
If you have more questions about a reverse mortgage, our experienced reverse mortgage specialists are wealth of information.
Get started by filling out the form here or go here to find a reverse mortgage specialist in your area.
Reverse mortgage borrower must occupy home as primary residence and remain current on property taxes, homeowner’s insurance, the costs of home maintenance, and any HOA fees.
This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.
