Reverse mortgages do make sense for some people, but they are not for everyone. You must own your home and either paid off your mortgage or have substantial equity in your home. Also, you must be 62 or older.
- There are significant advantages and disadvantages to tapping into your home’s equity.
- Make sure you understand all the criteria you need to meet to get the loan.
While there are cases where a reverse mortgage may make sense, we recommend that you use it as a last resort to deal with your financial situation.
Do Reverse Mortgages Make Sense? Pros and Cons
Reverse mortgages do have advantages, but they come with disadvantages that you should be aware of before you commit to the loan. While you can get a regular monthly income or a lump sum payment to take off a large bill, you can lose your home to foreclosure if you can’t maintain the property or fall behind on your bills.
What is the Upside?
The biggest upside is that you get a monthly check to live on from the equity in your home. Other advantages include:
- The options to receive a regular check or a one-time payment to cover a large bill
- The IRS doesn’t tax the payments
- FHA-insured loans are non-recourse, so you won’t owe more than 95% of your house’s appraised value
- You don’t pay the loan until you move, sell, or pass away
These advantages are important if you want to stay in your home, and you don’t have enough income to pay all the bills. It also makes sense if you have a large one-time payment and your credit scores are too low to get a home equity loan.
What is the Downside?
The biggest downside is that you are losing the equity in your house, and you could lose your home if your financial situation changes.
- If you aren’t at least 62 you won’t qualify.
- There are significant closing costs including an appraisal, a credit check, origination and processing fees, and mortgage insurance.
- Your heirs probably won’t be able to keep your house because they will have to sell it to pay off the loan.
- The loan becomes due if you must move into a long-term care facility.
You are responsible to keep up with taxes, insurance, and other bills such as homeowner’s association dues. In addition, you must maintain the house and make repairs if needed. If you fall behind on your bills or let your property run down, the bank will foreclose. You can lose your home.
Do Reverse Mortgages Make Sense; What are the Criteria?
Most reverse mortgages are Home Equity Conversion Mortgages (HECM) backed by HUD, and they have stringent criteria. Other lenders may not be as strict, but they lack the protections that FHA-insured loans offer. So, you should consider the HECM first and see if it fits your situation and needs. You:
- Can only get a HECM on your primary residence.
- Must own the home or have a low balance on your mortgage.
- Cannot be delinquent on any federal debt.
- Pay for property taxes, insurance, maintenance, and repairs
Private lenders may not have as strict guidelines on how much money you can borrow or the type of property you can borrow against. They also may not have all the guarantees that a HECM has, either.2
Is There a Maximum Amount?
There is a maximum amount you can get from a reverse mortgage. For HECMs it is $765,600 in 2020. This maximum increased each of the last four years. Non-FHA-insured loans will have limits as well depending on the value of the property, and they will vary based on each bank’s requirements.3
Is Mortgage Insurance Required?
HUD requires mortgage insurance premium (MIP) for HECM loans, but private banks may not make you get it. You pay a 2% MIP to the Federal Housing Administration (FHA) at closing and 0.5% annually for the life of the loan. The MIP guarantees:
- If your lender can’t service your loan, the FHA assumes responsibility so that your access to the funds won’t be interrupted.
- That you won’t be left with a large balance when you sell your home. It pays your lender the difference between the balance you owe, and the amount you sell your house for.
A private lender may not require mortgage insurance, but they also won’t have the protections that the FHA provides.
Do Reverse Mortgages Make Sense, Can You be Denied?
Banks can deny you for a reverse mortgage. Common reasons include:
- Age – You must be at least 62 years old.
- Credit, spending, and income – Lenders look at all three to decide whether you can afford to pay all your monthly expenses and maintain and/or make repairs on the property.
- The property – Most borrowers own a single-family home, but HUD may approve condominiums, multi-family buildings not more than four units, and mobile homes.
Even if you are disqualified you can reapply when your situation changes.5
What Type of Home isn’t Eligible?
Most single-family homes are eligible, but there are many types of properties that aren’t. They include:
- Second homes
- Properties with more than 50 acres
- Condominium conversions
- Properties zoned commercial or agricultural
- Dilapidated homes
There are other eligibility requirements for wells, mobile homes, and other features and improvements. Most important, though, is that you live on the property. It must be your primary residence.6
Do Townhomes Qualify?
Some townhomes do qualify, but HUD has not approved most condominiums. In order to get a HECM for a condominium the entire complex, not just your unit, must meet the FHA’s requirements:
- Proof of adequate insurance
- No individual owns more than 10% of the development
- Sufficient cash reserves
- 50% of the units are owner-occupied
Many homeowner associations don’t want the hassle of getting approved by HUD, and many won’t allow the individual to pursue approval either. Therefore, many developments aren’t approved. Your potential lender will find out for you if your development qualifies.7
Final Thoughts on Do Reverse Mortgages Make Sense
Reverse mortgages make sense for very few situations. If you want to stay in your home and can’t get a refinance or home equity loan is one case. Another is if you have a large, one-time bill that you can’t pay any other way.
Almost always, though, there is a better option. Reverse mortgages have high-interest rates and fees. Most of the time another loan or selling your house is a better solution. Never incur new debt unless you feel you have to.
Another consideration is your emotional attachment to your home. It’s where you lived and raised a family, but sometimes it’s better to let it go rather than clinging to it and bringing financial ruin. If you can’t stay in your home any other way, then you should consider selling the house and moving to a more affordable place. A financial counselor can give you an objective perspective on your situation that you may not be able to see.