(NewsNation) — Reverse mortgages are one way for older homeowners to borrow money against their home equity without having to sell, but they can also be financially risky.
If you’re 62 or older, you might qualify for a reverse mortgage, which is a tax-free loan that allows homeowners to access their equity without needing to make monthly payments.
But unlike a traditional mortgage, which leads to lower debt and more equity over time, a reverse mortgage increases your debt as monthly interest accrues and lowers your equity.
Here’s what to keep in mind.
Reverse mortgages explained
As the name suggests, a reverse mortgage is the opposite of a regular mortgage. Instead of the homeowner making payments to the lender, the lender makes payments to the homeowner. In exchange, the lender gets a stake in the home.
Think of it like an advance payment on your equity.
The most common type of reverse mortgage is the government-sponsored home equity conversion mortgage (HECM), which is only for homeowners 62 and older.
Homeowners who take out a HECM don’t make monthly payments. Instead, the loan gets repaid when the borrower sells the home, permanently moves away or dies.
The lender makes money through interest and fees, which get added to the balance each month. So unlike a traditional mortgage, the homeowner owes more, not less, over time.
“The homeowners or their heirs will eventually have to pay back the loan, usually by selling the home,” according to the Consumer Financial Protection Bureau.
Upsides of reverse mortgages
A reverse mortgage allows homeowners to get additional tax-free monthly income without having to move. The title to your home remains in your name and there are no restrictions on how you can use the money from a HECM.
Since there are no monthly payments, the extra income can help you budget and cover everyday expenses like medical costs, groceries, or credit card bills.
Borrowers can also decide how they get paid, whether that be a single lump sum, a regular fixed monthly payment or a line of credit they can access as needed.
The amount of money you can borrow is based on how much equity you have in your home and you won’t be able to take out more than the property is worth.
The Federal Housing Administration (FHA) sets a lending limit for HECM reverse mortgages every year. The current lending limit for 2024 is $1,149,825.
Also, you don’t pay taxes on reverse mortgage payments because the IRS classifies them as “loan proceeds,” not income.
Risks of reverse mortgages
A reverse mortgage can allow you to turn your equity into cash without selling your house but it also comes with risks.
For one, a reverse mortgage increases your debt and eats away at your equity, which means when you eventually go to sell your home, you could get nothing. The final debt isn’t owed until the end but interest gets added to the balance each month.
Reverse mortgages are generally considered an expensive way to borrow. You’ll have to pay mortgage insurance premiums, closing costs from third parties and an origination fee which can go as high as $6,000. Lenders may also charge a monthly servicing fee.
“The fees and other costs to borrow money this way can be higher than other alternatives like a home equity loan or home equity line of credit,” according to the Federal Trade Commission.
And because the title remains in the homeowner’s name, they’re still on the hook for homeowners insurance, property taxes and the home’s upkeep.
Family is also worth keeping in mind. It’s important to determine whether your spouse will be able to remain in the home after you die. You should also consider what your heirs may owe before taking on a reverse mortgage.
In order to be approved for a HECM, applicants have to meet with an HUD-approved HECM counselor.