Reverse Mortgages: A Great Tool for the Right Situation
October 3, 2022
By Jessica Lanning, JD, CFP®
Reverse mortgages are a great way for homeowners over the age of 62 to access the equity they have built up in their homes. These mortgages can provide cash flow for retirees, help them stay in their homes, and more. However, reverse mortgages are not right for everyone. In this blog post, we will discuss the pros and cons of reverse mortgages and help you decide if this is the right option for you. Or your parents. Or your grandparents.
What is a Reverse Mortgage?
A reverse mortgage is a type of home loan that allows homeowners to access the equity they have built up in their home. (Yes, it’s a terrible name.)
With a reverse mortgage, the borrower does not make any monthly payments. The interest owed on the loan accrues and is added onto the balance of the loan. That loan – whatever its size – is repaid when the borrower sells the home, no longer occupies it as a primary residence, or dies.
For example, let’s say a 62-year-old homeowner has $100,000 left on her mortgage. She also has an outstanding home equity loan of $50,000. She makes mortgage payments of $2000/month. Her home is worth $300,000. If she takes out a reverse mortgage for $150,000, she would have no monthly payments. If the interest on that loan is $1000, the next month, the loan balance will be $151,000.
Aren’t Reverse Mortgages Bad?
The original reverse mortgage product got a deservedly bad rap. Fees and rates were high, more money was lent than should have been, seniors lost their homes, and banks came after heirs for loan shortfalls when the home’s sale did not pay off the whole loan.
To this day, some people view them as a way for “greedy” lenders to take advantage of unsuspecting seniors.
These days, though, the product design is better, the fees and rates are more reasonable, and lenders can’t come after seniors or heirs if the loan balances exceed the home’s equity. There are also safeguards in place to make sure seniors cognitively understand what they are doing and the impact of their decision.
While there may be some unscrupulous lenders out there, the fact is that reverse mortgages can be a great tool for the right borrower.
What are the Pros and Cons of Reverse Mortgages?
Like any financial product, there are pros and cons to reverse mortgages. You should carefully consider all of the factors before deciding if a reverse mortgage is right for you.
Some of the pros include:
- No monthly payments required
- Access to equity that can be used for anything – retirement income, home repairs, etc.
- The loan is not due until the borrower moves out, sells the home, or dies
- The borrower continues to own the home and can live in it for as long as they want
Some of the cons include:
- The interest on the loan accrues over time, which increases the size of the loan balance
- The loan balance can exceed the value of the home – if the home’s value decreases or if the interest rate increases
- Borrowers are responsible for maintaining the property and paying taxes and insurance
Who Should Consider a Reverse Mortgage?
Reverse mortgages are one tool or strategy among many to manage a financial issue. They are not right for everyone. Here are some examples:
Example: Mom needs money for long-term care expenses
Let’s say Mom, 82, owns and lives in a $300,000 home with a $1000 mortgage payment, has $100,000 left in the bank, and receives income from Social Security and a pension, which total $3000/month. She owns a lake house as a second home. She now needs regular care that will cost $2000 a month that will likely increase as she needs more care and she refuses to live anywhere but in her home.
(“Move out?! Over my dead body!” she exclaims. Her death now clearly being the triggering event for moving her.)
A reverse mortgage might be a great option here:
- She can eliminate the $1000 mortgage payment.
- She can get additional cash out for her care.
- With her other income, the lower mortgage payment, and the additional cash, she probably has enough money to cover her for several years.
But also consider:
- She has a second home. If she could rent that out or sell it and cover her LTC expenses, that might be a better option. Her mortgage balance is not increasing and she’s leveraging that other asset.
- She will have less to pass down to her family if the mortgage balance is growing. The kids might consider contributing to her expenses rather than do the reverse mortgage.
- We have no idea how long she will need care and how long she can be cared for at home (severe physical issues and/or memory issues, for example). If she has to leave the home, the reverse mortgage has to be paid off through a sale of the home or a refinance.
Example: Retired couple wants more money for travel
Let’s say a couple in their 60s owns and lives in their home with a $2000/month mortgage, has $200,000 in retirement accounts, receives income from Social Security and rental property income, which total $5000/month. They’re expecting inheritance money. They want to travel the world and will be gone three or more months at a time.
A reverse mortgage might be a great option here:
- They can eliminate the $2000 mortgage payment.
- They might get additional cash out.
- This frees up money for travel depending on how lavishly they travel. This is especially true if they can do a house swap or rent out their home while away.
But also consider:
- They must live in the property for at least six months out of the year. If they no longer do so, the loan must be paid off by sale of the house or a refinance.
- Their home is their biggest asset and their “safety net.” Should they need to sell the property to manage long-term care expenses, a reverse mortgage will grow the loan and reduce the equity available.
- The expectation of an inheritance is a bird in the bush and probably shouldn’t be relied upon. The assets could decrease, the deaths triggering the inheritance might not happen for a long time, and they might need care before the deaths happen.
How To Decide
As with so many financial decisions, the numbers and one’s desires and values are intertwined.
For instance, in the first example, maybe that second home has been in the family for generations, and they do not want to sell or rent it out and want to be able to use it. That eliminates an option for additional revenue. Maybe the kids don’t care about inheriting her house and plan to sell it anyway when she passes, so they don’t care much about having less equity there so long as they get the second home.
In the second example, perhaps the desire to travel is worth the risk of having less equity in the home. Maybe the inheritance is pretty secure. If they have no kids to pass down the home to, maybe they are fine letting their last check bounce when they pass.
So, how to decide what to do?
First, start with the end in mind. In the big picture, what do you want? Create the plan around that first, and get the money to support that plan. If unpleasant decisions have to be made, what gets prioritized?
Second, run the numbers. Look at the different scenarios and the impact each has on the financial picture. Take any information and moments of clarity that might refine your priorities.
Third, make a decision, sit with it and sleep on it. Give your brain a few days to work on this while you go about your lives and revisit a few days later. Will you be happy with this decision five months from now? Five years from now? Twenty years from now? Do you need to change your decision?
Fourth, reaffirm your decision and execute.
Reverse mortgages can be a great tool for the right people in the right situation. If you would like to explore if this is a good option for you, please reach out.
Lanning Financial Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.