Is a Reverse Mortgage the Right Retirement Tool for You?

Many retirees have significant home equity but limited cash flow. A reverse mortgage allows homeowners aged 62 and older to convert part of their home’s value into usable funds without selling the property or taking on monthly payments.

While this can provide financial relief, it also comes with long-term implications. Understanding how a reverse mortgage works, its repayment terms, and its impact on heirs and taxes is essential before making a decision.

Eligibility Criteria

To qualify, homeowners must meet specific conditions beyond age. The property must be a primary residence, meaning vacation homes and investment properties do not qualify. If applying for a Home Equity Conversion Mortgage (HECM), the most common type, the home must meet Federal Housing Administration (FHA) standards, requiring it to be in good condition and compliant with safety regulations.

Lenders assess financial stability to ensure borrowers can cover ongoing costs like property taxes, homeowners insurance, and maintenance. Falling behind on these obligations can lead to default and foreclosure. To prevent this, lenders conduct a financial assessment, reviewing income sources such as Social Security, pensions, and retirement savings. If a borrower is deemed at risk, the lender may require a portion of the loan proceeds to be set aside for these expenses.

Payment Methods

Borrowers can choose how they receive their funds based on financial needs. A lump sum provides the entire loan amount upfront and is the only option for fixed-rate reverse mortgages. While useful for large expenses, it immediately reduces home equity.

A line of credit offers flexibility, allowing borrowers to withdraw funds as needed. Unlike a traditional home equity line of credit (HELOC), a reverse mortgage line of credit does not require monthly payments and grows over time based on the unused balance. This feature helps manage long-term expenses, preserving equity while keeping funds accessible.

Monthly payments can be structured as either tenure or term payments. Tenure payments continue for as long as the borrower lives in the home, while term payments provide funds for a set number of years. This approach supplements retirement income with a steady cash flow.

Repayment Conditions

A reverse mortgage does not require monthly payments, but the loan must be repaid when the borrower moves out, sells the home, or passes away. Repayment includes the borrowed amount plus accrued interest and fees. Since interest compounds over time, the longer the loan remains, the larger the repayment amount.

If the borrower sells the home, the proceeds must first go toward paying off the loan. Reverse mortgages are non-recourse loans, meaning the borrower or their estate will never owe more than the home’s market value at the time of sale. However, if the home’s value declines, there may be little or no remaining equity after repayment.

Failing to meet obligations like property taxes, homeowners insurance, or maintenance can trigger repayment and, in extreme cases, foreclosure. Some borrowers set aside loan proceeds to cover these expenses and avoid default.

Heirs’ Obligations

When a homeowner with a reverse mortgage passes away, heirs must address the outstanding loan. Since the lender has a claim on the property, beneficiaries cannot inherit the home outright without settling the debt. They have three options: repay the loan balance to keep the home, sell the property to pay off the debt, or allow the lender to take possession.

If heirs want to keep the home, they must pay either the full loan balance or 95% of the home’s appraised value, whichever is lower. This FHA guideline ensures heirs are not responsible for excessive debt if the property has depreciated. Those choosing to retain the home often refinance into a traditional mortgage or use personal funds to settle the obligation.

If the home is sold, heirs must coordinate with the lender to complete the transaction within six months, though extensions may be granted. If the property does not sell within this period, the lender may initiate foreclosure. Acting quickly—obtaining an appraisal and listing the home as soon as possible—helps avoid complications.

Potential Tax Factors

Reverse mortgage proceeds are not taxable income, as they are an advance on home equity rather than earnings. However, tax-related factors may apply depending on how the funds are used.

Interest on a reverse mortgage is not deductible on annual tax returns unless the loan is repaid. Unlike a traditional mortgage, where interest payments can be deducted each year, reverse mortgage interest can only be claimed when the loan is settled, typically when the home is sold. Borrowers who never repay the loan during their lifetime will not benefit from this deduction.

Using loan proceeds for investments, such as purchasing stocks or funding a business, may have capital gains or other tax consequences. Consulting a financial advisor can clarify potential liabilities.

Property tax obligations remain the homeowner’s responsibility, and failure to stay current can lead to loan default. Some states offer property tax deferral programs for seniors, but eligibility varies. Additionally, receiving a large sum from a reverse mortgage could affect eligibility for need-based government programs like Medicaid or Supplemental Security Income (SSI), as excess liquid assets might push borrowers above qualifying thresholds. Proper planning can help mitigate these risks.