Older couple stand in front of house

For homeowners age 62 and older, a reverse mortgage can be a simple way to secure extra income. These loans—which are a form of home equity loan—pay the borrower a set amount based on the borrower’s age and the equity that they already have in their home.

Many people choose reverse mortgages because they are easy to qualify for and do not need to be paid back until the borrower sells or vacates the home. However, while reverse mortgages can sound like a great deal, they do have drawbacks and are not always the wisest financial decision.

What is a reverse mortgage?

Most people buy their homes through a traditional mortgage: they make regular payments to their lender, and over time these payments increase their equity and decrease the amount owed. A reverse mortgage is just the opposite. Your lender makes payments to you, either in a lump sum or in monthly installments that accrue interest. The loan becomes due when you move, sell the house, or pass away.

In order to qualify for a reverse mortgage, you must:

  • Be 62 years or older
  • Own your home outright or have a considerable amount of equity (often 50 percent to 55 percent, or more)
  • Be able to afford all taxes and insurance on your home
  • Count your home as your primary residence
  • Have kept your house in good condition prior to taking out the reverse mortgage

The pros of a reverse mortgage

Many people of retirement age live on a fixed income, which can leave them struggling to meet rising expenses such as property taxes or medical bills.

For homeowners who may not have access to a home equity loan or a line of credit, a reverse mortgage can be a simple way to leverage their home equity into a reliable source of extra income. It can allow older people to stay in their homes, rather than being forced to rent or sell their property. This can be a significant benefit for those who don’t want to move but require some assistance maintaining their home as they age.

Another perk of the reverse mortgage is that, in most cases, the amount of the loan is limited to the value of the house. For example, if the final amount of the loan is $150,000 but the home could only be sold for $140,000, the borrower may not be responsible for paying the remaining $10,000.

The cons of a reverse mortgage

Despite their obvious appeal, reverse mortgages have some downsides. First, interest accrues over the course of the loan, meaning that your debt grows over time, potentially making it more difficult to pay off. Note that if you have a reverse mortgage, you may also make payments to the lender in order to reduce the balance.

Another drawback is that reverse mortgages stipulate that you must stay in the house for the length of the loan. If you eventually end up moving in with family or to an assisted living facility, the loan becomes due. Unless you have the cash on hand to repay the loan, this will result in the immediate sale of the home, affecting anyone else currently residing there.

If you pass away, your estate must settle the outstanding debt, just like any other loan. There is no requirement to sell the home, however the lender will contact the estate to work out the debt. If the loan balance exceeds the home’s value, you may need to sign a deed-in-lieu of foreclosure and give the house to the lender.

Before locking yourself into a reverse mortgage, weigh your options, and consider both the positives and negatives of these types of loans. For instance, you may find a more attractive alternative solutions, such as refinancing your existing mortgage or selling your home to your children.