Disadvantages of Reverse Mortgages: What You Should Know

If you’re planning to retire soon and need to access cash to help cover living expenses, a reverse mortgage may be a viable option. It’s possible to get approved without jumping through several hoops if you have equity in your current home. Still, there are drawbacks to these debt products to consider before moving forward. You could find that there are more viable ways to secure the cash you need to survive financially during retirement. 

How Does a Reverse Mortgage Work?

A reverse mortgage loan is a home loan product that caters to older homeowners or individuals who are approaching or have reached retirement age. But instead of receiving money from the lender to purchase a home, the loan proceeds will come from the equity you already have built up in your current home. 

You’ll get a lump sum, a line of credit, or monthly payments disbursed to you. Any interest that accrues on the loan gets added to the balance, which means it’ll grow over time and decrease your equity. When you relocate or pass away, the loan will be paid off by the sale of the home. 

If your home is worth more than what you owe and there’s remaining equity, it will be transferred to your estate. But if the opposite is true, your heirs won’t be responsible for the negative equity. That’s unless they wish to pay the reverse mortgage in full or refinance the balance with another lender to retain possession of the property. 

Ideally, your mortgage should be paid in full before you apply. However, you should also know that reverse mortgage products generally don’t come with stringent qualification criteria, which means you could be approved with a lower credit score or income. 

Assuming you remain in the home until you pass away, you won’t have to pay back the loan proceeds. However, you’re still responsible for homeowners’ insurance, property taxes and maintenance-related costs. 

There are three types of reverse mortgages to be aware of: 

• Home Equity Conversion Mortgage (HECM): You may qualify for this government-backed mortgage product if you are 62 years of age or older. It’s insured by the Federal Housing Administration (FHA), and the loan limit for 2022 is $970,800. 
• Single-purpose reverse mortgage: If you’re seeking a reverse mortgage with the lowest costs, this loan could be your best choice. It’s accessible through select nonprofits along with state and local government agencies, but the funds must be used for a specific purpose. 
• Proprietary reverse mortgage: These home loans are offered by private lenders and permit you to use the funds however you see fit. 

Advantages of a Reverse Mortgage

Before deciding if a reverse mortgage is right for you, consider these key benefits. 

Get Help with Your Retirement

The Social Security benefits and retirement income you’re set to receive may not be enough to cover your monthly obligations. But instead of worrying about how you’ll survive financially during retirement, you can have peace of mind knowing you have cash available if you need it. 

Stay in Your Home

A steep mortgage payment could mean you have to move when you retire if it’s no longer affordable. Or you can take out a reverse mortgage and stay put since you’ll no longer have to make monthly mortgage payments for principal and interest.  

Pay Off Your Existing Home Loan

Once you close on a reverse mortgage, the lender pays your current home loan in full. Plus, you won’t have to concern yourself with a monthly mortgage payment.   

No Tax Liability

The loan proceeds from a reverse mortgage are not subject to federal income taxation. You should consult with a reputable tax professional, though, if you have tax-related questions regarding these loan products. 

Disadvantages of a Reverse Mortgage

There are also several cons of reverse mortgages, of which you should be mindful. 

Risk of Foreclosure

A reverse mortgage releases you from the monthly principal and interest payments. Still, you’ll be on the hook for homeowners insurance, property taxes and HOA dues. Failure to remit timely payment for these obligations could lead to foreclosure. 

Less Inheritance for Your Heirs

The equity will decrease on your home over time, leaving less for your heirs to inherit when you pass away. 

Associated Costs 

Expect to pay steep mortgage origination fees and mortgage insurance premiums. You could spend several thousand dollars, depending on the lender. 

Impact on Your Other Retirement Benefits

There are instances where reverse mortgages impact your Medicaid or Supplemental Security Income (SSI) benefits. Consider speaking with an attorney or financial planner to determine if your benefits could possibly be decreased. 

No Tax Deductions Until the Loan is Paid

Unlike traditional home loan products that allow you to take advantage of the mortgage interest deduction when filing your taxes, you won’t have this luxury with a reverse mortgage.  

Is a Reverse Mortgage Right for You?

It depends on your unique situation. However, a reverse mortgage could be ideal if your income will decrease during retirement and you’ll need extra funds to cover living expenses. It could also be a good fit if you have no desire to relocate and would rather stay in your home until you pass away. 

However, a reverse mortgage probably isn’t a smart financial move if you plan to relocate to a new home soon or to an assisted living facility. You should also consider the costs of maintaining the home outside of the monthly principal and interest payment. If it’ll be too much to manage, you may want to explore other options. 

Consider an Equity Sharing Agreement Instead of a Reverse Mortgage

If a reverse mortgage’s disadvantages outweigh the benefits for your financial situation, there’s another hassle-free way to unlock the equity that you have in your home without having to fork over costly monthly debt payments.