Tax Help: What's a Reverse Mortgage, and What Can It Do For You?

Some seniors face a cash crunch even though they’re sitting on considerable equity in their home. They don’t want to take out a new mortgage because they may not be able to make the monthly payments. But if they’re at least 62 years old and have little or no mortgage remaining on a main home, there’s another alternative: a reverse mortgage.

About reverse mortgages

A reverse mortgage is a way for a homeowner of moderate means to take out equity from the home without have to make monthly mortgage payments. A reverse mortgage is a variation on the old financing scheme of “buy now pay later.” With this type of mortgage, you get funds up front; the lender is repaid when you move from your home or die (for married couples, repayment does not occur until the surviving spouse moves or dies).

You can borrow an amount based on your age, the equity in your home, and the prevailing interest rates. The amount you can borrow is reduced by any existing home mortgage. Don’t expect to borrow more than 40% to 50% of the total equity in the home. Usually, you can obtain the most cash through a federally insured “Home Equity Conversion Mortgage” (HECM). However, for expensive homes (usually $250,000 or more), you may need to go through private mortgage sources to obtain a higher payout.

There are also special fees to be paid for a reverse mortgage. The application fee and other costs can be rolled into the mortgage so there is no immediate out-of-pocket cost to the homeowner; the equity is simply further reduced.

The funds are paid to you in a lump sum, through a line of credit that you can draw upon, or as a fixed monthly draw on the line. Some lenders give you a choice; others do not.

Is a reverse mortgage a good idea for you?

This type of financing makes sense for some homeowners who want to remain in their home but can’t afford the upkeep. Instead of selling the home, it is mortgaged to obtain funds for paying bills and other purposes. No payment of principal or interest is required while the homeowner is in the home, giving a measure of financial freedom. But you must go through some educational process before you can obtain a federally sponsored mortgage.

However, if the owner wants to relocate or downsize, the proceeds from the sale will be reduced by the outstanding debt owed to the reverse mortgage lender. This can mean little or no remaining equity in the home for the seller.

A reverse mortgage may not be available in your situation. For instance, it is unlikely you can get one for a cooperative apartment or a mobile home.

Having a reverse mortgage usually means that there will be little, if anything, left for the homeowner’s heirs. The lender will first recoup the outstanding principal and interest on the reverse mortgage. If this mortgage has been in place for a long time, so that there is substantial interest owed on the loan, and housing prices have not appreciated substantially, most if not all of the sale proceeds from the home will be owed to the lender.