What is a Reverse Mortgage and How Does it Work?
By Reverse mortgages are not for everyone. Get the information you need about how a reverse mortgage works along the advantages and disadvantages before you commit to anything.
If you plan to enjoy an active retirement, a long life of leisure and the pursuit of new adventures can put a strain on your financial resources. In addition, with increasing expenses for things like property taxes, home maintenance and repair, and health care, to name a few, you may be concerned about your ability to maintain and retain the family home.
People reaching retirement today are likely to enjoy a life expectancy that is much longer than they ever expected. If you don't plan for a long retirement, you may find yourself running short on cash to pay for these expenses.
The combination of increasing expenses coupled with insufficient cash flow means many people will be looking for other sources of income.
Extra Cash in Retirement
A reverse mortgage is one option for retirees, age 62 or older, to receive additional income for a variety of reasons or to accomplish other financial objectives.
Benefits of a Reverse Mortgage
A reverse mortgage can be a useful tool for replacing lost income, paying for living expenses, and paying for health care expenses. It can also be a source of additional income to enhance your standard of living.
AARP and the U.S. Department of Housing and Urban Development (HUD) conducted a survey of reverse mortgage borrowers to learn how they used the proceeds. They found that households used reverse mortgages in the following ways.1
- Hospital/health care costs.
- Repay existing mortgages.
- Financial help to family.
- Home repair/improvement.
- Pay property taxes.
- Daily expenses.
- Improve quality of life.
- Pay off non-mortgage debt.
How a Reverse Mortgage Works
A reverse mortgage is exactly what the name implies. It is a loan on the equity in the home, which is paid out to the homeowner, either in monthly installments, a lump sum, a line of credit or a combination of the three.
Unlike a traditional mortgage loan where you incur a debt that has to be repaid, a reverse mortgage is a source of income. The lender makes payments to the homeowner instead of the borrower paying the lender. As with a standard mortgage, the homeowner remains the owner of the home and is still responsible for maintenance and property taxes. Unlike a traditional loan where you are required to make monthly payments to pay back the loan, with a reverse mortgage, you are not required to repay the loan until you move out or the home is sold.
Reverse Mortgage Disadvantages
In addition to the benefits described previously, reverse mortgages can be used as a creative financial tool to help people accomplish other financial objectives. But like just about any other financial vehicle or strategy, there are some disadvantages.
One barrier that may limit the use for some people is the upfront cost. This seems to be the most significant drawback. The upfront cost may include origination fees, mortgage insurance and other servicing fees. The expenses are similar to the upfront costs you typically would have when you refinance or take out a new mortgage loan. Some of the costs can also be built into the interest rate charged for the loan.
Another downside is the limit on the size of the loan. As a result of this limitation, many homeowners are not able to use the fair market value of their home to determine the loan amount due to the cap on home values.
Some people may also consider the age restriction a potential barrier. To qualify for a reverse mortgage, the youngest borrower must be at least 62 years old.
A reverse mortgage is not for everyone. For the right person, it can provide much needed cash and financial resources for those who want to maintain their independence in their own home.
1AARP Public Policy Institute; Report of the 2006 National Survey of Reverse Mortgage Shoppers.
Bill Griffith, Jr., CFP®
is principal of W.E.
Griffith & Associates, LLC,
a wealth management firm in Washington, Pennsylvania. He has been
providing specialized strategies and services for ensuring long-term
financial independence and security for many years. He has written
numerous articles about various topics relevant to personal finance,
retirement and investment planning and is author of the books Securing
a Retirement Income for Life and More Money for
Retirement Right Now.
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