by Gary Foreman

How do you determine if taking out a reverse mortgage is best for your financial situation? Depending on why you need to borrow, another option might suit your short- and long-term financial needs better.

Gary,
I am almost 80 years old, a widow, excellent health, no debts, and my house is paid off. I live on my social security with a small savings backup, and I manage to make my taxes and maintain a car and live well.

My children think I should take out a reverse mortgage and spend the money doing some traveling. They are all doing well and do not expect or want me to just save the house for them. Are there any pitfalls in this?
Betty

Yes, Betty, there are some pitfalls. Any time that you put your home up to secure a loan, there are dangers. They may be reasonable risks to take, but you need to know them. Let’s take a moment to understand reverse mortgages. Then we can better explore the risks and benefits.

How Does a Reverse Mortgage Work?

A reverse mortgage seems strange at first. The purpose of a reverse mortgage is to convert the equity in your home into cash.

Like a regular mortgage, you’re borrowing against your home. And, when you sell you’ll need to repay any balance on the mortgage. But instead of borrowing all the money at the beginning and then paying it back each month, this time you’ll borrow a little at a time and not repay the mortgage until the house is sold. In that way, it’s the reverse of a traditional mortgage.

What Are the Risks of Taking Out a Reverse Mortgage?

Now the risks. The first problem is that they’re somewhat complicated. And that can be a real issue for borrowers as they get older. Betty might understand everything today. But it’s not unreasonable to expect that she won’t be as sharp mentally in ten years.

Then there are expenses much like a regular mortgage. Betty’s house will need to be appraised. There will be an origination fee.

If Betty does borrow against her home, she needs to maintain enough equity for future needs. Her monthly living expenses could increase faster than her income. Or she might need to move into a nursing home. Her home is her only significant financial asset. She needs to guard it’s value carefully.

One payout option allows you to take fixed monthly payments for the rest of your life. That does protect you from losing your home during your lifetime. But it also means that you’ll only get the fixed income amount. And inflation can shrink fixed income streams. The other disadvantage is that you might not live that long. The mortgage company could be ‘buying’ your house fairly cheaply.

Once Betty takes out a reverse mortgage, she can pretty much expect to have it until she sells the home or dies. The reason is simple. She’s unlikely to have enough money to pay off the mortgage without selling the home.

Expert Interview: What Mature Homeowners Should Know about Reverse Mortgages

What Are the Benefits of Getting a Reverse Mortgage?

So what are the benefits to a reverse mortgage? A reverse mortgage would allow Betty to borrow against her equity as often as she likes. She could borrow for a trip or any unmet living expenses.

Since she’s borrowing the money it’s not considered taxable income to her. That can make a reverse mortgage better than selling stocks that have appreciated. Any stock gains will trigger income taxes.

Related: 3 Strategic Uses for a Reverse Mortgage Line of Credit

Some Steps To Take When Getting a Reverse Mortgage

If Betty wants to get a reverse mortgage, she’ll need to meet with a HUD approved counselor before she can get a reverse mortgage. You’ll find a list of approved counselors at HudExchange.info.

Before she actually applies for a loan and incurs those costs, Betty should compare the rates to other sources of cash. The closer to age 62 the easier it is to find other cheaper places to borrow.

Betty might want to check out something called the “Home Equity Conversion Mortgage” (HECM). It’s a federally insured mortgage.

She’ll need to decide whether she wants a one-time payout, the ability to borrow whenever she wants, or a set monthly payout. Single purpose loans are generally the least costly. But over 60% of homeowners choose to use a line of credit type payout.

Ultimately the home will be sold. At that time the value of the home will be broken into three parts: the amount borrowed, the costs associated with that borrowing and leftover equity that will go to Betty or her estate.

3 Question for Comparing Reverse Mortgages

The best way to compare reverse mortgages is to answer three questions about each mortgage.

1. How much money will you get?
2. How much will it cost you?
3. How much equity will be left when you sell or die?

Should Betty use a reverse mortgage? A little travel sounds nice. But she might find a home equity loan a little easier to manage than a reverse mortgage.

Related Articles

• Things To Consider Before Borrowing a Reverse Mortgage To Delay Collecting Social Security
• Can a Reverse Mortgage Safely Boost Retirement Income?
• Can a Reverse Mortgage Leave You Homeless?

Reviewed September 2022

About the Author

Gary Foreman is the former owner and editor of the After50Finances.com website and newsletter. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com.