What Is the Downside to a Reverse Mortgage?

A reverse mortgage is a financial product tailored for homeowners aged 62 or older, enabling them to convert a portion of their home equity into cash while maintaining property ownership. 

Unlike a traditional mortgage, the borrower is not required to make any payments on a reverse mortgage. Instead, the lender pays the borrower monthly or as a lump sum. This unique feature of a reverse mortgage can provide retirees with an additional income stream, but it’s essential to weigh the pros and cons. 

We’ll share what you should consider before getting a reverse mortgage. By evaluating whether this loan is right for you, you’ll be better equipped to make an informed decision about your financial future.

How does a reverse mortgage work?

A reverse mortgage is a type of loan available to homeowners 62 years of age or older. When the lender pays the borrower, the amount might be distributed as a single sum or monthly payments. The borrower doesn’t need to repay the loan until they decide to sell the home, permanently move out of the property, or pass away. When one of these events happens, the home is usually sold to repay the loan. 

Pros and cons of a reverse mortgage

Here are the pros and cons of this product. Keep reading for more.

Pros

• Source of income for retirees

• Convert home equity to cash

• Financial flexibility

• Enhanced retirement lifestyle

Cons

• Interest is added to the loan balance

• Reduced equity for heirs

• Risk of outliving the home’s equity

• Risk of losing the home to foreclosure

What is the downside of a reverse mortgage? 

Reverse mortgages offer retirees financial benefits but have significant downsides worth considering.

Interest is added to the loan balance

Interest is a cost associated with any mortgage. With a traditional mortgage, the accrued interest is added to your monthly payment. Every time you make a payment, a portion goes toward reducing the loan balance, and another goes to cover the interest charges. 

However, with a reverse mortgage, because you don’t make monthly payments, the accrued interest is added to your loan balance, and your mortgage balance increases each month—even if you don’t borrow any more money. This accrued interest can result in substantial debt and erode the equity in your home.

Reduced equity for heirs

As interest accumulates and the loan balance grows, the equity in the home decreases. Home equity—the difference between the property’s market value and the outstanding loan balance—diminishes over time. 

This reduction in equity may affect the financial legacy left for your loved ones. With decreased equity, it may become more challenging for heirs to use it as an asset in their financial planning, which could limit their financial options and security.

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Tip

Your heirs generally aren’t responsible for repaying more than 95% of your home’s appraised value when they sell it, with any remaining balance covered by mortgage insurance. 

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Risk of outliving the home’s equity

A significant risk associated with reverse mortgages is the potential of outliving the home’s equity, particularly if you rely on the monthly income the reverse mortgage generates. 

If you exhaust the equity and continue to depend on the home for income, you may face financial instability in retirement. This risk is heightened if you live longer than expected or if the loan balance grows faster than the value of the home appreciates. 

It’s crucial to plan and consider alternative financial strategies to avoid the risk of running out of equity during retirement.

Risk of losing the home to foreclosure

Failure to meet financial obligations, such as property taxes, insurance premiums, homeowner association (HOA) fees, and maintenance expenses, can lead to foreclosure. It’s crucial to keep up with these obligations to avoid the risk of losing your home. 

Falling behind on these payments puts you at risk of losing your home and jeopardizes the lender’s interest in the property. Foreclosure can have severe financial and emotional consequences, including losing your primary residence and damaging your creditworthiness. 

Staying current on these expenses is essential for maintaining the security of your home and financial stability.

What are the benefits of a reverse mortgage?

Reverse mortgages offer valuable benefits for retirees seeking financial security and flexibility in their retirement years.

Source of income for retirees

A reverse mortgage can be a helpful source of income for retirees, providing a steady stream of funds without the need to sell their homes or take on additional debt requiring monthly payments. 

This income can supplement retirement savings, pension, or Social Security benefits, helping retirees cover living expenses, healthcare costs, or other financial needs. 

By tapping into their home equity, retirees may be able to enjoy greater financial stability and peace of mind during their retirement years.

Convert home equity into cash

One of the benefits of a reverse mortgage is the ability to convert home equity into cash. Retirees can access a portion of the equity built up in their homes over the years, providing a valuable financial resource. 

Whether they need funds for home improvements, medical expenses, travel, or other uses, a reverse mortgage offers a flexible solution to access the wealth tied up in their property without selling or downsizing.

Financial flexibility

Reverse mortgages can offer retirees increased financial flexibility, allowing them to use their home equity as needed to meet their evolving financial goals and obligations. 

Whether it’s paying off debt, covering unexpected expenses, or supporting family members, retirees can leverage their home equity to address a wide range of financial needs. 

This flexibility can provide a sense of security and independence.

Enhanced retirement lifestyle

The ability to access equity through a reverse mortgage can enhance retirees’ lifestyles during their golden years. Whether funding leisure activities, pursuing hobbies, or enjoying travel, retirees can use the additional funds to enrich their retirement experience. 

By leveraging their home equity to finance their lifestyle aspirations, retirees may be able to enjoy a more fulfilling and comfortable retirement without worrying about financial constraints. This enhanced quality of life could contribute to overall well-being and happiness in retirement.

Who is a reverse mortgage right for? 

A reverse mortgage may be suitable for homeowners aged 62 or older who seek to supplement their retirement income, especially if they have limited savings, significant home equity, and don’t plan to leave their home as a significant inheritance. 

However, it’s essential to consider the potential drawbacks and whether alternative financial options align better with your goals and circumstances.

Consider a reverse mortgage if…	Reconsider a reverse mortgage if…
You’re a homeowner aged 62 or older.	You have alternative sources of income or assets to meet your financial needs.
You want to supplement your retirement income.	You plan to leave your home as a significant inheritance.
You have limited savings or investments.	You’re concerned about accruing interest on the loan balance.
You have significant equity in your home.	You prefer to maintain no debt on your home.
You aren’t worried about using the equity your heirs might inherit.	You can’t afford to maintain the home.

When to consider a reverse mortgage

A reverse mortgage can be a good option for homeowners 62 years of age or older who want to supplement their retirement income. If you have limited savings or investments and a good amount of equity in your home, a reverse mortgage can provide much-needed funds.

By tapping into your home equity, a reverse mortgage offers a way to bolster your retirement finances without monthly payment obligations. This extra income can be beneficial if you face unexpected expenses, such as medical bills or home repairs.

A reverse mortgage can also be suitable if you’re not planning to leave your home as a significant inheritance. By leveraging your home equity, you can create an additional income stream in retirement.

When to reconsider a reverse mortgage

Reconsider a reverse mortgage if you have alternative sources of income or assets to meet your financial needs, or if leaving your home as a significant inheritance is a priority. 

Exploring other financial strategies may be more suitable if you’re concerned about accruing interest on the loan balance or prefer to avoid having any debt outstanding on your home.

Also, avoiding a reverse mortgage is crucial if you can’t afford to maintain the home, including keeping it in good repair, paying property taxes, and keeping your insurance up-to-date. You might risk losing the home to foreclosure.

See our resource on a home equity line of credit versus a reverse mortgage if you’re not sure which product is right for you.

FAQ

Do people lose their homes with a reverse mortgage?

In typical circumstances, homeowners do not lose their homes with a reverse mortgage, provided they adhere to loan conditions. These include maintaining home insurance, staying current with property taxes, and keeping the home in good repair. 

However, a reverse mortgage loan becomes due if the homeowner permanently leaves the home. So if you plan to leave your home to your heirs, it’s crucial to consider the loan repayment implications.

What is the unique risk of a reverse mortgage?

A unique risk associated with a reverse mortgage revolves around home equity. This type of loan will decrease the equity in your home by using it as a source of money for your retirement. As a result, the equity left over for your heirs will be reduced. 

Plus, if the housing market plummets, you may find that the loan balance ends up being higher than the home’s value. Remember, a reverse mortgage is a loan and must be repaid.

Is a reverse mortgage a good idea for seniors?

The suitability of a reverse mortgage depends on individual circumstances. For some seniors, a reverse mortgage could offer a financial safety net, allowing them to stay in their homes and earn a steady income stream. 

However, it’s crucial to be aware of the costs, including closing costs, ongoing mortgage insurance, interest charges, and loan servicing fees. If a senior has other more cost-effective ways to meet their financial needs, they might prefer to use these first.

What factors should I consider before taking out a reverse mortgage?

Before taking out a reverse mortgage, it’s essential to consider the condition of your home, your ability and willingness to pay for upkeep, your need for monthly income versus a line of credit, and your desire to leave an inheritance for your heirs.

We recommend working with a financial professional specializing in senior homeowner issues to ensure you’re making an informed decision.

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