The Pros and Cons of Cashing In
A reverse mortgage can be a powerful tool for converting home equity into cash that can help you make ends meet. However, reverse mortgages also present some financial risk.
How reverse mortgages work
Reverse mortgages work like traditional mortgages, only in reverse. Rather than paying your lender each month, the lender pays you. These payments are actually cash advances against the equity in your home.
The maximum amount that can be borrowed is usually based on the age of the homeowner, the appraised value of the home, and the current interest rate.
Generally, the more equity you have in your home, the older you are, and the lower the interest rate, the more you can tap into it for cash. With most lenders, you may choose to receive your payment as a lump sum, in regular monthly payments, as a line of credit you can draw against when you need cash or some combination of these options.
You continue to own your home and are responsible for property taxes, operating expenses and maintenance. Because you make no payments on the loan, the balance owed increases each month as interest is applied and compounds.
To qualify for a reverse mortgage, you must be age 62 or older, and you must occupy the home as your principal residence. Your home must be owned free and clear or have a small outstanding mortgage balance that can be paid off with the reverse mortgage. Unlike a traditional mortgage, there are no income, employment or credit-qualifying requirements.
What about repayment?
With a reverse mortgage, repayment is due when you die, sell your home, or no longer occupy it as your principal residence. At the time that payment is due, there is no requirement that the property be sold, only that the loan be repaid. This may be achieved through the sale of the home or through other resources.
Pros of reverse mortgages
- The cash payments you receive are tax-free since they are loan proceeds and not income, and they generally do not affect Social Security or Medicare benefits.
- There are no minimum income requirements to qualify and no credit checks.
- You can use the money for any purpose.
- You may be able to create a cash flow stream for the remainder of your life.
Cons of reverse mortgages
- Reverse mortgages are complex. In fact, you must attend a counseling session before applying for a reverse mortgage.
- Your eligibility for state and federal government assistance programs such as Medicaid may be affected.
- Reverse mortgages can have very high up-front closing costs. If you think you might move in a few years, a reverse mortgage may not be the best decision. They make the most sense for those who plan to stay in their homes permanently.
- Reverse mortgages are relatively expensive. The interest is added to the loan balance each month, and the total interest you owe increases greatly over time as the interest compounds.
- A reverse mortgage uses up the equity in your home, so it reduces what you have left to leave your heirs.
Consult with a CPA
Your home may be your most valuable asset. Before you tap into the equity in your home, consult with a CPA who can examine your financial situation and help you determine if a reverse mortgage makes sense for you.
(Updated and reviewed 2016)
Copyright, The American Institute of Certified Public Accountants