How Does a Reverse Mortgage Work?
A reverse mortgage allows persons age 62 and older who own a home to use the equity in their home to create tax free income. Instead of creating new loan payment obligations, as would be the case with a traditional home equity loan, the lender makes payments to the homeowner— either in a lump sum, in fixed monthly payments or via a line of credit. The homeowner is never required to repay the mortgage until he or she moves out of the home, at which point the proceeds of the sale of the home are used to pay off the mortgage obligation.
Reverse mortgage proceeds can be used for anything the homeowner needs, whether for retirement vacations, home improvements, new cars, normal living expenses, property tax payments or otherwise.
Unlike a normal mortgage where the debt balance declines over time, with a reverse mortgage the debt balance increases over time as more of the equity in the home is drawn down. Typically, the equity balance declines with a reverse mortgage, unless the value of the home is appreciating rapidly.
Is a Reverse Mortgage Right for Me?
When considering whether a reverse mortgage is right for you, you should keep in mind:
- How long you intend to live in your home: A reverse mortgage has high upfront costs, which make it a particularly costly option if you plan to leave your home within the first few years of getting a reverse mortgage.
- Whether you plan to pass your home on to your heirs: Typically, a reverse mortgage is paid off from the sale of the property. If, however, you are planning to pass your home on to your heirs, they will need to come up with cash from other sources to pay down the reverse mortgage, as the reverse mortgage becomes due once you no longer live in the home.
- Potential impacts on Medicaid benefits: If you spend your reverse mortgage proceeds each month, you will not have excess cash that is considered an asset for purposes of determining Medicaid benefits. If, however, you were to take a lump sum payment of reverse mortgage proceeds, your Medicaid benefits could be impacted if you do not immediately spend these funds. At present, you would not be eligible for Medicaid benefits if your excess cash exceeds $2,000 for an individual or $3,000 for a couple.
- Whether you will need your home equity for other reasons in the future: If you anticipate major life expenses in the near to medium term such as major home repairs, assisted living, other medical issues, etc., it may make sense to postpone tapping this equity, as it will give you more cushion in the event of a financial emergency down the road. Also, the longer you wait to put a reverse mortgage in place, the more borrowing capacity you will likely have, given that you will be older, your house should be worth more and the reverse mortgage lending limits should be higher.
What are the Alternatives to a Reverse Mortgage?
If you think a reverse mortgage might not be a good fit for you, you might also consider:
- Home equity loan: If you have sufficient equity in your home and you can afford the monthly payments, a home equity loan or line of credit may be a good option for you.
- Downsizing: Strongly consider selling your home and moving into a smaller or less expensive home. This may be a more cost effective way to tap into your home's equity.
- Government assistance: There are a variety of government programs that you can leverage as an alternative to drawing down a reverse mortgage, including various property tax relief programs, prescription drug programs, energy assistance and more. To find out what programs are available in your area, contact your local Area Agency on Aging. To find your local Area Agency on Aging, call 1-800-677-1116.
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