Recently we tackled a bunch of questions and concerns about reverse mortgages, perhaps the most controversial loan product in home financing. For some homeowners the high fees surrounding a reverse mortgage make it less attractive the closer they look at it, but for others the cashflow in retirement is a lifeline. Lenders offer a variety of loan products because not everyone's the same. A reverse mortgage is not for everyone, but it could be a good fit for you.

If you're a longtime homeowner with certain circumstances and goals, a reverse mortgage could appeal to you. To help you decide if this loan product makes sense with your lifestyle, we answer a bunch more question that many people have about reverse mortgages.

First, What's a Reverse Mortgage Again?

An ordinary mortgage is when you borrow money to buy a home. From the first dollar you pay on the loan principal you start building equity, a fancy term for home ownership. A reverse mortgage is a loan product that generates payments to you based on your home's value and defers repayment until you move, sell, or pass away.

And Who's a Reverse Mortgage Meant For?

A reverse mortgage is an income strategy for older homeowners who want to stay in their home. Compare it to the typical way for older homeowners to cash in on the appreciation of their home, which is to sell after retirement and downsize. Downsizing may mean not only buying a smaller home but also a home in a more affordable region now that proximity to jobs and schools is no longer a concern. That's fine for homeowners who want to roam, but what if you're certain you want to stay in your current home? Reverse mortgages are a possibility for you.

What If I Change My Mind About Staying in the Home?

That's the major question each homeowner must wrestle with when considering a reverse mortgage. The answer is personal for each individual. Since a move would trigger repayment, some homeowners can feel trapped by their reverse mortgage. People who were once certain that they would be happy living nowhere else come to realize after three or four years of retirement that they want to downsize and relocate, especially if friends and family have moved away. In order to keep from triggering the payback of the reverse mortgage, borrowers could be forced to remain in a home longer than they want.

You cannot rent out the home and relocate either. As we discussed last time, every year you must certify in writing that you occupy your home as your principal residence, according to the Consumer Financial Protection Bureau. You can lose your home to foreclosure if you have a reverse mortgage loan and:

  • Are absent from your home for a majority of a year for a nonmedical reason; or
  • Are absent from your home more than 12 months in a row for healthcare purposes.

Do I Have to Pay Taxes on the Reverse Mortgage Payments?

No, the income is nontaxable. As controversial as reverse mortgages are, an indisputable benefit of a reverse mortgage is that the payments are not considered taxable income. Because the IRS sees the money as a loan rather than income, it will not be counted in formulas that derive your income, such as Social Security and Medicare benefits.

Are All Reverse Mortgage Programs the Same?

No, they aren't. Stick to the type called the home equity conversion mortgage (HECM). These loans are made through an FHA program. If your reverse mortgage is not done through the FHA program, it probably won't have the crucial consumer protection that keeps you or your heirs from having to pay back a loan balance that's grown larger than the home is worth.

One stipulation of the FHA program is that you must be at least 62, and so must your spouse (source).

Can I Bequeath My Home to My Children?

Yes, your home remains part of your estate, which you can dispose of as you wish. But death triggers repayment of the reverse mortgage, and the responsibility falls on your estate. Many older homeowners expect their home to be sold after they pass away, so this isn't a concern. They know that the home's sale will repay the reverse mortgage and leave no burden to their heirs.

If you want the home to stay in the family, a reverse mortgage makes that unlikely. Most reverse mortgages are repaid by the sale of the home. So while a reverse mortgage can be repaid through the sale of the home and thus leave no burden on your heirs (if the home sells quickly), it also leaves them no property.

"If you have to shell out big bucks for fees or create an unnecessary burden for your children, a reverse mortgage could be more trouble than it’s worth," wrote Rebecca Lake, a retirement and estate planning advisor for SmartAssset. "You may go through the reverse mortgage application process and find that the associated fees are quite high. If this describes your situation, you should likely steer clear of a reverse mortgage. There are other options for gaining money in retirement, so don’t feel overly attached to this option."

Two of the fees you would pay to take out a reverse mortage are origination and appraisal costs. Origination costs are legally capped at $6,000 for a home equity conversion mortgage (HECM). The cost of an appraisal varies from place to place, and an appraisal is mandatory with a reverse mortgage application.

Even though a reverse mortgage might look like it turns your home into an ATM, it's more like turning your home into a credit card. It is debt, with interest and fees and a balance that grows every month.

Be Wary of Sales Pitches

We conclude this Q&A session with sensible advice from the Federal Trade Commission. If you are considering taking out a reverse mortgage, talk with a counselor from an independent government-approved housing counseling agency because "a salesperson isn’t likely to be the best guide for what works for you. This is especially true if he or she acts like a reverse mortgage is a solution for all your problems, pushes you to take out a loan, or has ideas on how you can spend the money from a reverse mortgage" (FTC).

Takeaways

  • A reverse mortgage keeps you in your home; in fact, moving out would trigger repayment.
  • The payments to you are not taxed as income.
  • Only consider reverse mortgages done through the FHA program so the loan balance can never eclipse your home's value.