The Pros & Cons of Reverse Mortgages
Reverse mortgages have been gaining visibility, but few understand the real pros and cons they can hold. So what do homeowners need to know about reverse mortgages before diving in, and are they right for you?
Pros and Cons of Reverse Mortgage
As the name suggests a reverse mortgage essentially works the opposite of conventional home purchase and refinance mortgages. Instead of receiving a chunk of money, and paying it down to increase equity over time, reverse mortgages pay out to homeowners over time and deplete equity.
The idea is that those with free and clear homes can use their equity for regular paydays, without having to worry about loan payments or debt. So what are some of the most important pluses and minuses of this scenario that homeowners need to be alert too?
The income is the big perk and reason that most will consider taking out a reverse mortgage loan. Instead of needing to earn income in retirement, or use retirement income to pay for housing, the house pays retirees. A reverse mortgage provides regular distributions from home equity. This is great, and perhaps a must for those that don’t have the retirement savings or income they need to survive, enjoy the later years in life, and spoil children and grandchildren. For those with lots of home equity, but no heirs to leave property to, or charities passionate about leaving something to, this can be a great move. After all, you can’t take it with you.
However, there are two big issues to watch out for. All reverse mortgage loan programs can be slightly different, so be sure to read the fine print and ask questions until you understand what all the terms mean.
One of the most important is pre-payment penalties. While standard home loan pre-penalties might range from a modest 1% to 3% of the balance, reverse mortgage penalties can be extreme. In the past some have had provisions which required borrowers to hand over half of their equity if they paid off their loans early. For those experience significant equity growth and home appreciation this could stretch into the realm of hundreds of thousands and even millions of dollars.
The second, and perhaps more obvious potential pitfall of reverse mortgages is outliving your life expectancy. What happens if you live a decade or more beyond what you anticipated? If you run out of equity, will you also run out of income and be forced to move out? Where will you go then?
Reverse mortgages can be a great option for some homeowners. However, others might still find it wise to look into the pros and cons of reverse mortgage, as well as other options such as conventional refinance loans or home equity lines of credit. A line of credit could simply be used in emergencies. A refinance could provide a substantial lump sum of cash now. In good times savvy investors could theoretically use these funds to invest and generate enough yield to pay down the loan, and keep quite healthy spreads as cash flow for living on.