Reverse Mortgages and Retirement

What is a Reverse Mortgage?

A reverse mortgage operates in the opposite manner of a traditional mortgage. With a traditional mortgage, the homeowner pays the lender, decreasing debt (the mortgage loan balance) and increasing equity (ownership) in the home over time. With a reverse mortgage, the lender pays the homeowner—there are no monthly repayments to the lender. Over time, equity decreases while debt increases. In essence, a reverse mortgage converts a home into cash; a traditional mortgage converts cash into an owned home.

 

Other Benefits of a Reverse Mortgage

One of the key benefits of a reverse mortgage is that it allows a homeowner to "age in place." Reverse mortgage borrowers continue to own the home, must pay property taxes, keep insurance in force, and maintain the home. The loan terminates when the last homeowner dies, sells the home or moves permanently (such as to an assisted living facility). At that point, the proceeds from the sale of the home (or other resource) can pay off the reverse mortgage balance.

 

Tax Implications of a Reverse Mortgage

The proceeds received from a reverse mortgage are free from federal and state income tax and can be used for any purpose. The interest that will eventually be paid when the reverse mortgage is retired is tax-deductible, but only at the point when the reverse mortgage is paid off. Borrowers can receive income from a reverse mortgage as a lump sum, as a line of credit that they can draw on when needed, as a monthly income for life, or as a combination of these options.

 

How a Reverse Mortgage Works

The age of the borrower and the value of the borrower’s home are the two primary factors affecting the amount of a reverse mortgage. The older the borrower, the more they can borrow. Likewise, the higher the value of the home (up to certain limits), the more they can borrow. The maximum amount of a reverse mortgage is roughly about 57 percent of a home’s value. Lenders typically want to see no debt on the home (or perhaps a very small amount) before they will offer a reverse mortgage. In most cases, the maximum amount a borrower can access in the first year of the loan is 60 percent of the loan amount.

 

Let’s look at an example. Assume a borrower has a $200,000 home with no debt and:

  • The variable interest rate on the reverse mortgage will be 2.5 percent
  • Closing costs on the reverse mortgage will be approximately $6,500

Here are the amounts a borrower could receive at different ages.

Age 62 67 75
Line of credit $105,000 $110,000 $118,000
Monthly payment $566 $618 $732

 

Under what circumstances could a reverse mortgage make sense for me?

If you plan to live in your home until you pass away, a reverse mortgage may offer you a significant source of cash. Ideal candidates for a reverse mortgage will be in good health, in their later 60s or older, and have long life expectancies of 15 or more years. At a minimum, all borrowers must be age 62 and go through mandatory mortgage counseling. Because of the high upfront costs of a reverse mortgage, you also should have exhausted nearly all other forms of financial resources (personal savings, retirement accounts, cash value life insurance, etc.) before using a reverse mortgage.