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What You’ll Gain From Reading This Article: Reverse mortgages provide retirees with supplemental, tax-free income without monthly payments but come with high costs and potential impacts on home equity and government benefits. Learn about the importance of weighing these pros and cons to make an informed decision about a reverse mortgage.
The name “reverse mortgage” almost speaks for itself. These types of mortgages reverse a home’s equity accumulation through payment(s) to the homeowner. To understand the pros and cons of reverse mortgages, we’ll explain each element of the mortgage one step at a time.
A good starting point for these loan products is eligibility which includes applicants aged 62 years old and above. Another qualifying criteria is the value of a home’s equity and any preexisting debt on the property. The pros and cons of reverse mortgages differ from person to person. However, there are three financially important benefits.
Advantages of a Reverse Mortgage
- It can eliminate the need for monthly rent or mortgage payments.
- It allows for additional cash flow during retirement.
- It is not considered taxable income.
The net gain is essentially an increased tax-free “income.” The terms of the loan cover the cost of that income. Additionally, for borrowers near taxable state estate values, a reverse mortgage may reduce net worth enough to bypass the tax. Costs of reverse mortgages aren’t necessarily prohibitive. Although, they are often cited as a disadvantage that outweighs the advantages of a reverse mortgage.
The reality is tenured reverse mortgages can never cost more than the value of the home. Also, tenured payments are perpetual, at least in the case of the Department of Housing and Urban Development (HUD) Home Equity Conversion Mortgages (HECM). These are very important loan features because they protect the homeowner and any heirs from unmanageable debt burden and longer than accounted-for lifespan.
Disadvantages of a Reverse Mortgage
- There’s a relatively high upfront and backend cost.
- The cost in proportion to the size of the loan is worth consideration.
Upfront costs for a reverse mortgage can be between 3-4% of a home’s determined value for HUD loans. This cost does not include monthly insurance premiums and assessed interest on the loan as it grows. As the reverse mortgage increases in size, the origination fees and mortgage premium decrease as a percentage of the total income received from the loan. Heirs of reverse mortgage holders be they a spouse or other beneficiaries become responsible for the loan in the event of death.
Naturally, equity values and interest rates at the time of the reverse mortgage are another factor to consider. Reverse mortgages have different payment structures called tenure, term and line of credit. In the case of line of credit, a Home Equity Line of Credit (HELOC) costs less upfront particularly if the interest rate is similar to a reverse mortgage line of credit.
The pros and cons of term and tenure reverse mortgages rest in:
- the formula used by the lender
- the age and life expectancy of the borrower
- the market value of the home at the time of the mortgage
- the specific terms of the loan
In summary, reverse mortgages help homeowners convert home equity into cash. Payment on reverse mortgages is not due to the lender until after leaving or selling the home, and the loans are available in both fixed and variable interest rates. The primary feature of these types of mortgages is their distribution of supplementary income during retirement. The built in safeguards of reverse mortgages can also protect homeowners from foreclosure, an advantage that allows the homeowner to remain in the home indefinitely.
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