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What you need to know about reverse mortgages
You can use your home's equity to do a number of things, but knowing the risks is crucial.
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There’s no shortage of ways to fund your retirement — including accessing your savings, downsizing homes or using your pension. But would-be retirees who own their own homes have another option: reverse mortgages. Just be sure you know the risks in addition to the potential benefits.
1. A reverse mortgage lets you borrow against your home’s equity
A reverse mortgage lets you borrow against your property’s equity and spend the funds as you’d like. You repay the debt — plus interest — when you sell the property.
- Reverse mortgages let those aged 62 or older borrow a percentage of their equity. Generally, the older you are, the more you can borrow.
- Equity is the value of your home, minus any remaining debt. If you’ve paid off your entire mortgage, then you have 100% equity.
- You don’t have to repay any of the equity you borrow right away, but you are charged fees and interest over time.
- You repay the debt when you move out of your home — this usually happens when you sell the property, move into a senior living facility or die.
Before borrowing from your home’s equity, it’s critical to understand how reverse mortgages work and the costs involved.
Consider the following risks:
- Borrowing against your equity means there’s a mortgage against your home. When you sell the property, a portion of the sale price will go to your reverse mortgage lender to repay the debt. This would also reduce the value of the estate that remains for your beneficiaries.
- As interest compounds over time, your debt will grow.
- Reverse mortgages can reduce the capital available for future costs, such as medical expenses.
- Reverse mortgages often include ongoing fees or an upfront fee based on the amount borrowed.
Reverse mortgages are complex products. Seek legal advice and speak with a financial adviser before taking out this type of loan.
How much can you borrow?
Every reverse mortgage lender has a different maximum they are willing to lend. This amount can vary depending on your age and the value of your home.
Borrowing limits are typically set well below those of standard home loans, which let you borrow 80% of a property’s value or more. Most reverse mortgages are generally 45% of your equity if you’re 90 years old, and progressively lower depending on how much younger than that you are.
These limits mean when you sell your property, you could still get some of the profits back once your debt is repaid. But remember that interest charges will add up every month, increasing your debt and reducing your equity in the property. You are, however, free to make repayments toward the debt at any time. Some lenders also allow you to apply to get those repayments back if needed.
2. You can access your equity in multiple ways
One advantage of reverse mortgages is their flexibility. You’re only charged interest on the amount of equity you access, and you can access it in different ways for different purposes.
Common ways to use a reverse mortgage include:
- As regular monthly payments. You can choose to receive a regular ongoing payment, perhaps to supplement your income. Some providers offer quarterly or annual payments to cover large expenses.
- As a line of credit. This option allows you to borrow a set amount with the option to use some of the equity now and more of it later.
- As lump-sum payments. Some lenders allow you to borrow a single lump sum to cover a large expense.
Note that different reverse mortgage lenders have different rules regarding how much you can borrow and how you can receive the payments.
3. You can continue living in your home while funding your new lifestyle
One of the biggest benefits of a reverse mortgage is that you can stay in your home while accessing funds.
Many retirees wish to stay in their family homes rather than downsizing or moving into senior living facilities. A reverse mortgage can make this easier to achieve.
You can use the money from a reverse mortgage to pay for anything, including:
- Renovations. You may find that you need to renovate your home to make it more comfortable during your retirement. A reverse mortgage can help you fund this expense and let you stay in your home.
- Major purchases. A reverse mortgage can pay for major purchases, such as a vacation or car.
- Supplemental income. A regular ongoing payment from a reverse mortgage can add to your income when you retire, letting you leave your savings untouched.
- Debt. You can also use a reverse mortgage to consolidate or repay existing debts.
4. You can repay your reverse mortgage in various ways
The standard way to repay a reverse mortgage is by selling your property. You receive the proceeds of the sale, minus the money you’ve borrowed against your equity. You’ll also be charged interest on the borrowed amount and you may have to pay lender fees.
But there are other repayment options as well. Some lenders offer unlimited additional repayments for reverse mortgage borrowers. This effectively allows you to repay what you’ve borrowed early, rather than waiting until you sell. This added flexibility can help reduce your overall interest costs.
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Bottom line
A reverse mortgage can provide you with the financial flexibility you might need in your later years — and you won’t have to pay the balance back until you move out. But knowing the risks is crucial to your financial wellbeing. Compare reverse mortgages to find out how much you could qualify for.
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