Types of reverse mortgages
Not all reverse mortgages are structured in the same way. Here are three main types of reverse mortgages:
1. Single-purpose reverse mortgages: A single-purpose reverse mortgage allows qualifying retirees to pull funds out for a specific, lender-approved reason, such as replacing a roof or paying a tax debt. This type of loan isn’t available in every state, and in some areas it’s only an option for low-income applicants.
2. Proprietary reverse mortgage: The proprietary reverse mortgage typically appeals to more affluent retirees. That’s because they allow a greater amount of equity that can be borrowed against the value of the home.
3. Home Equity Conversion Mortgage (HECM): The Home Equity Conversion Mortgage (HECM) loan is only available through a lender approved by the Federal Housing Administration (FHA) and is the only reverse mortgage insured by the US government. Single-purpose and proprietary reverse mortgages are private loans, so they aren’t subject to as many regulations as a government-backed loan. They are also not insured by the federal government. HECM loans offer seniors a federally insured reverse mortgage.
As a protective measure, the U.S. Department of Housing and Urban Development (HUD) requires all applicants to work with an HECM counselor who will use HUD-approved Reverse Mortgage Analyst software to help determine whether a reverse mortgage is the right financial option for you.
In another step to protect retirees, the federal government also regulates how much equity can be pulled out with an HECM loan. The HECM lending limit is $1,149,825 as of 2024, regardless of your home’s current market value.
Reverse mortgage pros and cons
No matter which type of reverse mortgage you settle on, they all come with pros and cons.
Reverse mortgage pros
Here are four reverse mortgage pros to consider:
Pro #1: You can tap into your home’s equity and pocket cash
If you’re in a position to qualify for an HECM, you’ve likely spent years paying off your traditional home loan until it’s become a large nest egg. With a reverse mortgage, you can pull out a portion of that equity without selling your home as a means to access its cash value. You continue living in the property and the title remains in your name.
A reverse mortgage functions much like a home equity line of credit (HELOC), where a bank lends you cash using your home’s equity as collateral. Those funds are then given to you as a lump sum, a line of credit, or in monthly installments paid to you.
Nile Lundgren, a top real New York estate expert with more than a decade of experience and $300M in sales, understands why this type of loan is attractive to some retirees:
“For Americans who don’t have retirement savings, the home they own free and clear may be the most effective way to fund a retirement,” Lundgren says. “What makes a reverse mortgage so appealing is that retired homeowners can turn the value of the home into cash without moving or having to make monthly payments.”
Pro #2: You can keep living in your home
With housing prices rising alongside inflation, you may be worried about being priced out of your neighborhood. Reverse mortgages can protect you in this situation. That’s because, with reverse mortgages, you can keep your home, continue to live there, and gather cash, without having to move or downsize. Ultimately, that means reverse mortgages could allow you to stay in the home and neighborhood you love, even if you’re feeling financial pressure at retirement.
Pro #3: You can avoid monthly mortgage payments
Unlike a traditional home equity loan, retirees can access their home’s equity without making monthly mortgage payments to the lender. Instead, the bank pays you, providing you, as a retiree, with a reliable source of income.
“If you take a senior over 62 who’s living on a fixed income or living in a house and they’ve worked their whole life, do they really need to make mortgage payments until they die?” asks Terry Williams, a retirement mortgage specialist at Fairway Independent Mortgage Corp. who has more than 20 years of experience in residential mortgage loans. “It gives you the opportunity to make voluntary mortgage payments and not mandatory mortgage payments.”
It’s worth noting that you won’t need to pay back the reverse mortgage monthly, but that doesn’t mean you’re completely free from house-related bills. You’re still responsible for things like property taxes, utilities, and homeowners insurance payments.
Pro #4: You can reap tax benefits
Another major advantage of reverse mortgages for homeowners is that they carry tax benefits.
“There’s a strategic tax advantage with reverse mortgages,” Williams says. “A reverse mortgage can be used as a strategic tax-claiming tool when implemented properly.”
One of the biggest tax benefits these mortgages provide includes a chance to pocket money during retirement without owing the government. According to the IRS, the reverse mortgage payments you receive aren’t taxable. That’s because the government considers reverse mortgages to be loan proceeds instead of income. So reverse mortgages let you live in your home while you pull in tax-free cash. HomeLight suggests you always consult a tax advisor before making any tax related borrowing decisions.
Reverse mortgage cons
Unfortunately, reverse mortgages aren’t a perfect solution for every homeowner. Here are a few of the biggest reverse mortgage cons to consider:
Con #1: They come with origination fees
Even though reverse mortgages throw cash your way, they aren’t completely free. In addition to paying mortgage insurance premiums, you’ll also need to pay origination fees. These fees generally sit at 2% of your home’s value and are designed to cover the processing costs for your loan.
Con #2: They may complicate need-based income eligibility
Even though reverse mortgages aren’t taxable, they may affect certain programs, such as Supplemental Security Income (SSI). That’s because need-based programs sometimes carry monthly liquid resource limits, and your reverse mortgage payments may push you toward that threshold or affect your program eligibility if you hang on to them too long. Still, it’s worth noting that Social Security and Medicare are not needs-based programs, so they shouldn’t be affected by reverse mortgage payments. Consult your tax advisor.
Con #3: They carry foreclosure risk
Even though reverse mortgages free you up from having to shell out mortgage payments, you’ll still have costs. You’ll need to meet typical payment obligations, such as fees, homeowners insurance, or property taxes. If you aren’t able to keep up on those payments, you could end up defaulting on your loan. And if you default, your home could end up in foreclosure.
Williams says that, although the homeowner still has obligations under reverse mortgages, those responsibilities are fairly straightforward.
“The only thing they’re required to do to honor the contract is pay the homeowners insurance, pay the property taxes on time, live in the property, and maintain the property,” he says.
Con #4: They shrink your equity and your inheritable estate
A reverse mortgage is a great way for you as a homeowner to find greater financial freedom in retirement. However, when you tap into your home’s equity, you risk eventually tapping it out.
Although a reverse mortgage doesn’t require a monthly payment, it’s still a loan that must eventually be paid off.
Lundgren explains: “People might think it’s free money, but just be aware that you have to pay it back. It’s critical when you’re doing a reverse mortgage to talk with a reverse mortgage specialist because you’re basically borrowing against the value of your home.”
It’s critical to remember that with a reverse mortgage you are borrowing money. With a traditional mortgage, your loan balance is paid down over time. With a reverse mortgage, your loan balance goes up.
If there comes a time when you need to sell your home to cover major expenses, you may not have enough equity left to cover the payoff of the reverse mortgage debts.
