Is a reverse mortgage right for you? Explore the benefits and drawbacks to make an informed decision.
Reverse mortgages have become a popular financial planning tool for seniors looking to leverage their home equity to support their retirement. These loans allow homeowners aged 62 and older to convert a portion of their home equity into cash, providing a potentially steady source of income without the need to sell their home or take on monthly mortgage payments. For many, this can be a lifeline, offering financial flexibility and peace of mind.
However, reverse mortgages are not suitable for everyone. The decision to take out a reverse mortgage should be made with careful consideration and an understanding of the potential risks and rewards.
In my experience, I have seen various scenarios where a reverse mortgage could lead to financial instability rather than security. Therefore, I have curated a list of the top 16 reasons I would discourage, or at least advise careful reflection, before pursuing a reverse mortgage.
When to Avoid a Reverse Mortgage
- Planning to Move Soon: If you are considering moving out of your home within a few years, a reverse mortgage might not be the best option. Home Equity Conversion Mortgages (HECMs) are designed for long-term residency. A major factor to consider is the upfront costs associated with reverse mortgages. If you move soon, you might not stay in the home long enough to recoup those dollars.
- Moving Gives More Financial Options: Staying in your home can become expensive due to aging in place, property taxes, upkeep and maintenance. Rightsizing to a more affordable living situation may be a better financial option. If your home needs significant maintenance or repairs, the costs can quickly consume the funds from a reverse mortgage, leaving you with little financial gain.
An alternative to downsizing is the HECM for Purchase (H4P) program, a type of federally-insured reverse mortgage that allows you to buy your next home with about 60% down and no monthly loan payments.
For example, a recent client sold their home and had $600,000 in proceeds. They moved into a $400,000 home that suited their needs perfectly. By utilizing the HECM for Purchase, they were able to move into their new home with a $250,000 down payment, using part of the proceeds from the sale of their previous home. This left them with $350,000 in cash to add back to their savings, providing increased financial stability and flexibility for the duration of their retirement. - Proceeds Don’t Cover Existing Mortgage: Sometimes the proceeds from a reverse mortgage are not enough to cover the outstanding balance on your existing mortgage, which is a requirement for obtaining a reverse mortgage. In such cases, you would need to supplement the shortfall with funds from your savings or other qualified sources. While this can be a great way to eliminate monthly mortgage payments, it can also lead to financial hardship if using those funds strains your budget or depletes your savings significantly. Careful consideration is essential to ensure that covering the shortfall does not negatively impact your overall financial stability.
- Struggling with Basic Living Expenses: If you already have trouble affording essential expenses like property taxes, homeowners’ insurance and utilities, a reverse mortgage might not solve your financial woes. Before pursuing a reverse mortgage, it’s important to evaluate your current budget to see if you can realistically afford ongoing home expenses.
- Uncertain Long-Term Health Prognosis: If you have a medical condition with an uncertain long-term prognosis, taking out a reverse mortgage might not be the best choice. Significant health issues could necessitate spending the loan proceeds too quickly as well as moving to a healthcare facility sooner than expected.
- Non-Borrowing Spouse: This happens when you obtain a reverse mortgage, but one spouse is not yet 62 years old. Having a non-borrowing spouse can complicate matters. Though the federal government has allowances to ensure that the non-borrowing spouse has the right to stay in the home after the borrowing spouse dies or is incapacitated, any access to the line of credit or monthly payments being received from the reverse mortgage will cease. Clients must assess beforehand a strategy to account for that possibility.
- Non-Conventional Relationships: Sometimes the particular situation of a couple is very unique. For example: If you are both over 62 and dating, but not married, or married but not living together. Or, possibly separated but not divorced, or in a second marriage with a blended family. Beginning a reverse mortgage with these dynamics and legalities requires clear guidelines, boundaries and concise communication. Even at their best, unique family circumstances can still complicate the reverse mortgage process. Understanding the implications on each party involved is crucial.
- Caring for Individuals with Special Needs: If you have dependents with special needs living with you, it’s essential to carefully consider how a reverse mortgage could affect their living situation. The requirement to sell the home upon the borrower’s death or move could disrupt their living arrangements and support systems. Will they have stable housing and continued care if the home must be sold?
- Taking Care of Adult Children: If you have dependent children or feel you are vulnerable to financial exploitation, a reverse mortgage could put you at greater risk. Living with addiction, either personally or within the family, or being overly generous to the point of irresponsibility with the funds a reverse mortgage could produce can lead to financial instability.
- Future Plans for Assisted Living: If moving to an assisted living facility is a planned part of retirement, a reverse mortgage could deplete home equity that might otherwise cover the cost of such care. To clarify, when I mention assisted living, I do not mean custodial care in a nursing home. Assisted living typically means you pay a large lump sum amount to “buy in” and then pay monthly rent, which according to the National Council on Aging is averaging around $5,350. With the potential high cost of buy-ins, preserving home equity would be crucial and a reverse mortgage might not be the right choice.
- Challenges with Overspending: If you struggle with managing money, a reverse mortgage could exacerbate financial issues. The temptation to overspend on non-essentials like gifts to adult children, gambling or online shopping can lead to the rapid depletion of funds meant for long-term stability. Before considering a reverse mortgage, evaluate your spending habits and implement strategies to control spending to ensure that the funds from a reverse mortgage are used wisely.
- No Financial Plan or Strategy: Entering a reverse mortgage without a clear plan can be risky. The closing costs associated with a reverse mortgage, including origination fees, mortgage insurance premiums and other expenses, are often higher than those of traditional loans. While most clients don’t strictly need a reverse mortgage, it’s most effective when integrated into a proactive financial strategy. We have identified 52 such retirement enhancement strategies. Whether wealthy or of modest means, having a clear understanding of how incorporating housing wealth strengthens your retirement income plan ensures the reverse mortgage serves a multi-pronged purpose. Using it solely for a single purpose, such as a home renovation or specific project, might not justify the long-term commitment.
- Opposition from Adult Children: If your adult children strongly oppose the idea of a reverse mortgage, it can strain family relationships. Some retirees worry that defying their children’s wishes could affect their bond with grandchildren. While financial stability should be a priority, potential familial discord is a significant consideration. Having open and honest discussions with your adult children about your financial needs and goals can help alleviate tensions.
- Inheritance Concerns: If leaving your home free and clear for your heirs is a priority, a reverse mortgage might not be the best choice. The loan balance increases over time, potentially depleting the equity left to your heirs. However, with wise planning, it is possible to use a reverse mortgage and still leave significantly more total wealth to your heirs. For example, if income needs are supplemented with the proceeds from a reverse mortgage instead of drawing from a portfolio during a bear market, the likelihood increases that the portfolio will last 10-14 years longer, potentially leaving a larger inheritance.
- Disagreement Among Co-Borrowers: If there is a clear disagreement between co-borrowers about taking out a reverse mortgage, it’s a red flag. Both parties need to be on the same page, as lack of consensus can lead to ongoing conflict and stress, undermining the potential benefits of the reverse mortgage.
- Lack of Understanding About Reverse Mortgages: Entering into a reverse mortgage agreement without thoroughly understanding the terms, conditions and long-term implications can lead to unpleasant surprises. Ensure you are fully educated about how HECMs work, including the costs, repayment terms and impact on your estate. Take the time to thoroughly research reverse mortgages by attending seminars, reading reputable sources, and asking questions until you feel confident in your understanding.
You might ask, “Don, why provide such a comprehensive list of cautions and considerations?” Because, after 16,000 consultations and 3,000 clients, I’ve seen firsthand that reverse mortgages can be a game-changing tool for the right person. However, they are not always the best fit.
Careful consideration of the specific circumstances and potential pitfalls outlined in these 16 points is essential for making an educated choice. Consulting with a reverse mortgage-educated financial professional can provide valuable insights and ensure that a reverse mortgage, if chosen, serves as a beneficial component of your overall financial strategy.
Alternatives to a Reverse Mortgage
If a reverse mortgage still doesn’t seem like the right fit for you, here are eight alternatives to consider that might better align with your goals and circumstances:
- Sell and Move: Selling your home and moving to a more affordable place can provide financial relief and eliminate the need for a reverse mortgage.
- Cash in Other Resources: Utilizing other financial resources such as savings, investments or retirement accounts can provide the needed funds.
- Borrow from Family: Family members might be willing to lend money, often with more favorable terms than a reverse mortgage.
- Traditional Loan: Taking out a traditional home equity loan or line of credit and making monthly payments could be a more straightforward option.
- Roommate: Renting out a part of your home can provide additional income.
- Employment: Part-time work can supplement your income and help meet financial needs.
- Local Programs: Many local and state programs offer financial assistance for seniors, including help with home repairs and living expenses.
- Wait/Do Nothing: If the financial strategies and benefits of a reverse mortgage don’t add value and peace of mind, waiting or doing nothing might be the best option.
By Don Graves