Using a Reverse Mortgage to Pay Off Debt

For homeowners 62 and older who have accumulated debts that create a financial strain, there’s another option beside traditional home equity loans or home equity lines of credit.

It’s a reverse mortgage.

You’ve probably seen TV commercials about it, but you may not understand exactly what reverse mortgages are all about and how they might – or might not – be worth considering as a way to pay off other debts.

Reverse mortgage loans were created to help older Americans access the equity in their homes while ensuring that they can live in the home until death. They can borrow from 40% to 60% of the home’s equity – a value determined by what the home is worth minus any existing mortgages – and don’t have to make monthly payments. The loan doesn’t have to be repaid until the house is sold or the last qualifying family member living there dies.

A big difference between a reverse mortgage and a conventional mortgage is that the amount the homeowner owes the lender increases rather than decreases over time. This is because interest and fees are added to the loan balance each month. As the loan balance increases, the home equity decreases. The homeowners or their heirs will eventually have to pay back the loan, usually by selling the home.

Can I Use a Reverse Mortgage to Pay Off Debt?

You can pay off debt with a reverse mortgage. Should you? It depends.

When you take out a reverse mortgage, the interest and fees accumulate year by year and ultimately may cost more than you if you’d made your debt payments. Also, unless you control the spending that caused the debt problem, you may end up in the same predicament. You need to weigh the pros and cons.

» Learn More: Types of Reverse Mortgages

Advantages of Using a Reverse Mortgage to Pay Off Debt

Depending on your circumstances, using a reverse mortgage to pay off debt can be a positive. Reverse mortgages tend to work best if your home has increased greatly in value. If you have a lot of equity in your home, you may be able to take out a reverse mortgage and still have money left over for your estate. Also, it’s better if you plan to stay in your home for a long time to make it worth the upfront costs involved.

Some of the pros for reverse mortgages include:

• By paying off creditors, you’ll have more money each month for things you need or want. This is especially true if, like many retirees, you don’t have a lot in savings but have considerable equity in your home.
• Those extra dollars make it more likely you’ll be able to age in your home by spending on ordinary maintenance or home modifications.
• Reverse mortgages are not taxed because they’re considered to be a loan advance rather than income. Also, they don’t affect government benefits like Social Security or Medicare.
• Even if the value of your home drops, you and your heirs are protected. Neither of you will have to pay the balance if the home value becomes less than what is owed.

Disadvantages of Using a Reverse Mortgage to Pay Off Debt

As with any financial tool, reverse mortgages aren’t right for everybody. There are potential pitfalls.

Some of the cons for reverse mortgages include:

• You also must keep up with maintenance, insurance and property tax payments or you may lose your home to foreclosure.
• There are upfront expenses. You must pay an upfront insurance premium, typically 2% of your home’s appraised value, plus loan origination fees at closing. You can roll these costs into your loan balance, but that means you receive less money.
• Although a reverse mortgage is not considered income for tax purposes, it could affect your ability to qualify for need-based government programs such as Medicaid or Supplemental Security Income. Check first to ensure your eligibility won’t be compromised.
• The interest and fees that accrue must eventually be paid back to the lender, chipping away at equity. That means you’ll no longer have access to that equity for other major expenses, and it could mean your heirs will get less – or even nothing – from the sale of the home when you die.
• If you live away from the home for more than 12 consecutive months, the loan may become due and payable. That is true even if you needed to move into a nursing home.
• You cannot rent out your home once a reverse mortgage is registered against it. The home must be your primary residence. However, as long as you live there, you can have roommates and charge them rent.

» Learn More: How to Stop a Foreclosure

What Can I Use Reverse Mortgage Funds For?

You can use the money from a reverse mortgage to fund whatever you want to spend it on. Some common items include:

• Credit card debt
• Car loans
• Vacations
• Home renovations
• Medical bills
• Offset healthcare costs to age in place
• Have a safety net fund for unexpected expenses.
• Help loved-ones

» Learn More: Help with Credit Card Debt

Work with a Nonprofit Credit Counselor

A reverse mortgage may be right for you, or there may be other strategies that will better enable you deal with debt. If only there was a free way to get expert advice to help you make that decision.

Actually, there is. And it’s required if you’re seeking a Home Equity Conversion Mortgage (HECM), which is the most common type of reverse mortgage loan.

The Federal Housing Administration requires that homeowners receive reverse mortgage counseling to make sure they understand the risks and financial responsibilities before making this move. This must be completed with a counselor approved by the U.S. Department of Housing and Urban Development. The counseling includes a financial assessment of their income, assets, and debts to ensure borrowers can pay for property taxes, homeowner’s insurance, basic home maintenance and, if applicable, HOA fees.

Nonprofit credit counselors can do more than determine if you’re financially able to take a reverse mortgage. If your primary motivation for a reverse mortgage is to pay off debt, there may be other – and better – solutions for your situation, which a credit counselor can help you discover, such as debt management plans or debt consolidation. The best credit counseling agencies will help you find the root cause of your debt.

As with any big financial decision, get as much information as you can if you’re considering a reverse mortgage to pay off debt.