Understanding Reverse Mortgages
A reverse mortgage might be a good financial move for some homeowners, but be sure to work through the associated costs and benefits.
If you've heard the term "reverse mortgage" before, there's a good chance it was first because you watched a commercial on daytime television. Also known as a "home equity conversion mortgage," reverse mortgages became especially popular among U.S. homeowners around 2009, according to The New York Times. Unfortunately, a number of these loans were created and marketed by less reputable lenders, and they fell out of favor once the housing market began to recover from the 2008 recession.
However, reverse mortgages are becoming popular and attractive once again, bolstered by tougher regulations and recent trends in the housing market. Homeowners should work to understand exactly what a reverse mortgage is and how it differs from other home loans like a home equity line of credit, for example.
Reverse mortgage basics
As explained in an article from the National Council on Aging, a reverse mortgage works by converting equity built up in a home into liquidity (cash). This makes it similar to a home equity loan or line of credit, but there are a few distinguishing features in a reverse mortgage:
- A reverse mortgage does not need to be repaid in full until the borrower either moves out of the home or fails to meet the loan's terms.
- Borrowers do not make any regular payments on a reverse mortgage until the home is sold, but they still must pay property taxes and homeowners insurance.
- To qualify for a reverse mortgage, lenders usually require borrowers to be at least 62 years old and live in the mortgaged home as their primary residence.
Benefits of a reverse mortgage
The terms of most reverse mortgages are geared toward seniors because of their more favorable repayment periods, compared to a typical HELOC. While a HELOC may need to be repaid within several years, a reverse mortgage doesn't need to be repaid until the home changes hands for any reason, which can take quite a long time. This might make a reverse mortgage a better option for retired homeowners who are concerned about running short on savings and want to establish a safety net of sorts.
Reverse mortgages tend to work best for homeowners who have already paid off all or most of their first mortgage and therefore have accrued a sizeable amount of equity, as explained by a lender who spoke to Realtor.com. It's also ideal if he or she plans to stay in the home for the foreseeable future.
Understanding the risks
Like any loan, including a traditional mortgage, a reverse mortgage is not without risks and drawbacks. Reverse mortgages accrue interest over time that must be paid when the homeowner decides to sell or passes away. Particularly in the latter event, this can cause some financial issues. If the owner dies and the repayment period kicks in, that debt will pass to the next-of-kin. This might be considered an advantage if the deceased owner has children and planned to have them inherit the home. But if the reverse mortgage has exhausted all the equity built up in the property, they could face very high payments.
Similar to a HELOC or a traditional mortgage, reverse mortgage borrowers might find themselves in a pickle if their home's value decreases over the life of the loan. Declining home values could wipe out built-up equity much faster than expected, putting borrowers at risk of insurmountable debt once they move, sell or pass away.
Finally, there's the loan's fees to consider. Realtor.com explained that reverse mortgage origination and closing costs tend to be much higher than those of a HELOC or a traditional mortgage. According to Bankrate, a reverse mortgage could include closing fees in the thousands, while those of a HELOC would typically be in the hundreds. Looking at fees alone, reverse mortgages tend to be more expensive overall than a HELOC.