What Is a Reverse Mortgage Loan?

What Is a Reverse Mortgage Loan?

As you near retirement, you'll need to have a clear idea about your expected level of income to make sure you have enough money to live comfortably. You might not think that you'll have enough income despite having enough net worth to retire. This can happen if the equity in your home makes up a substantial percentage of your net worth. If you find yourself in this situation, you might consider a reverse mortgage. But what is a reverse mortgage loan and how does it work?

What Is a Reverse Mortgage Loan?

A reverse mortgage is a way to convert the equity you have in your home into cash to supplement your existing retirement income, pay for health care expenses or fund other needs you might face in retirement.

Think of it this way: When you take out a regular mortgage to finance a home, you pay the lender each month to increase your equity in the house. With a reverse mortgage, you receive a loan against your home, and a lender pays you in exchange for equity in it. As your loan balance increases, you receive more money, but the equity you have in your home decreases.

How Does a Reverse Mortgage Work?

To qualify for a reverse mortgage loan, you must be at least 62 years old, and you must hold significant equity in your home or own it outright. If you meet these qualifications, you can borrow against the value of your home and receive funds either as one upfront lump sum (similar to a home equity loan), over time as a monthly payment or as a line of credit. Federal regulations limit how much lenders can offer to ensure that the value of the home remains sufficient to repay the loan.

These payments don't count as taxable income because the IRS considers this loan an advance. You also usually don't need to pay back the money as long as you keep living in the home. You will have to pay property taxes, maintenance expenses and insurance costs, though. You repay the loan if you move out or sell the home; if you die before the mortgage is repaid, your spouse or your estate repays the loan.

Reverse mortgages come with risks — such as high fees — and might not make sense for everyone. Make sure that you understand the potential implications and consult a financial professional before proceeding.

Considering a Reverse Mortgage

Before getting a reverse mortgage, you must understand its potential advantages and disadvantages.

Potential Advantages

  • A reverse mortgage provides income for living expenses. A reverse mortgage can be a reliable source of income in retirement if most of your net worth comes from your home's equity.
  • You can stay in your home. As long as you cover the relevant expenses attached to the reverse mortgage, you can stay in your home.

Potential Disadvantages

  • You lose equity to pass to heirs. The more money you take in a reverse mortgage, the less equity you have in your home, diminishing your estate.
  • There can be significant fees and interest costs. Reverse mortgage loans assess upfront premiums, mortgage insurance and interest, eroding your home's equity.
  • Some reverse mortgage scams target the elderly. Reverse mortgages can be useful to retirees with fixed incomes, but that also leaves these retirees susceptible to reverse mortgage fraud.

Should You Get a Reverse Mortgage Loan?

If much of your net worth is tied to the equity you've accumulated in your home and you don't have many other assets, a reverse mortgage loan could provide you with some much-needed retirement income. As you decide what's best for you, make sure that you're aware of the costs tied to taking out a reverse mortgage loan and that you talk to the right financial advisors.

Riley Adams, CPA AuthorThumbnail

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