Despite a healthy dose of industry hype, reverse mortgages haven't really clicked with older U.S. homeowners -- only 3% of Americans have a reverse mortgage, according to data from the U.S. Census Bureau.
In a word, a reverse mortgage is a financial contract where a homeowner relinquishes equity in their home to a reverse mortgage provider, in exchange for regular cash payments, usually to bolster retirement income.
"Reverse mortgages, which can also be identified as Home Equity Conversion Mortgages, or HECMs, are a specific type of home loan offered by the Federal Housing Administration," says Mary Tillery, a loan originator and a real estate mortgage instructor with At Your Pace Online, an online education company. "A reverse mortgage allows homeowners, age 62 or older, who either own their own property or have a small mortgage balance, to use the equity in their home as the basis for a new loan.
A reverse mortgage allows the homeowner to essentially access the equity from their home, while still living in it. "When the homeowner no longer lives in the home (either because they have passed away or moved out for at least one year), the entity who issued the reverse mortgage requests that the loan be repaid, either through the property sale or a payoff from the heirs," Tillery says.
Are reverse mortgages a good move for older homeowners? It depends, mortgage experts say.
"Reverse mortgages are great for individuals who are looking for a consistent, guaranteed income but this product does have its downsides," says Evan Roberts, a real estate agent with Dependable Homebuyers, in Baltimore, Md.
For example, when you take out a reverse mortgage, you are unable to apply for additional home equity loans in the future, Roberts explains. "This can be an issue if a major expense arises, like surgery or big home repairs, that you can't afford on a fixed income," he says.
Other real estate experts say that reverse mortgages come with risks, and need to be studied thoroughly by consumers.
"You don't want to get a reverse mortgage unless you are in the need of income or money," says Michael Foguth, founder of Foguth Financial Group, in Brighton, Mi.
Foguth says there are several pros and cons to getting a reverse mortgage.
"One reason why you would not want a reverse mortgage is that the interest you aren't paying compounds against you," he explains. "One reason you would want a reverse mortgage is that you're in need of income or assets that you cannot get from anywhere else."
A reverse mortgage is also not a good idea for older homeowners unless there is nowhere else to obtain needed cash. "Remember, the person or company lending you the money will benefit financially," he adds. "However, a retiree/homeowner could also benefit because they can stay in their home and do not have to move."
There are more "pros" and "cons" to obtaining a reverse mortgage, says Elysia Stobbe, author of the bestselling book, "How to Get Approved for The Best Mortgage Without Sticking a Fork in Your Eye."
"One big benefit is the reverse mortgage homeowner can live in the house until they pass away," Stobbe says. "Plus, they get paid to live in the house either by a lump sum, monthly payments, or a combination of both."
The main disadvantage is the homeowner doesn't get full value on their house. "In addition, there's a risk the homeowner won't have a debt-free asset for their children," she says.
Other mortgage experts say there are better financial options than reverse mortgages -- and thinking small is the best of those options.
"I usually recommend my clients look at downsizing their home before looking to take out a reverse mortgage, says Eric Meermann, a certified financial planner at Palisades Hudson Financial Group, in Stamford, Conn. "Not only will this put extra cash in your pocket to help pay for retirement expenses, it will also lower the sometimes forgotten about costs of homeownership."
Meermann says a larger home requires more maintenance and upkeep, may have more land that will need lawn care, costs more to heat and cool, and has a higher property tax, among other cost issues. "A reverse mortgage does nothing to reduce these types of living expenses," he says. "Selling your larger home and downsizing can reduce a lot of these expenses, and increase the likelihood that your net worth will be able to support you throughout your retirement."
The main reason to downsize is to capture some of the home equity in your home and turn it into liquid cash, Meerman adds. "I advise my clients to then invest this lump sum in a diversified portfolio of stocks and bonds, setting an asset allocation in line with their risk tolerance, spending needs and financial goals," he explains. "The aim is to create a cash flow that the client can live off of while protecting principal, and potentially also growing the portfolio for the long term."
That may be a more rational idea than a reverse mortgage, and underscores the need to discuss a reverse mortgage with a financial advisor.
"Reverse mortgages can be an extremely beneficial arrangement for retirees who plan to live in their homes for some time, who do not have heirs, or who do not have any other source of income," says Tillery. "However, this should only be carried out by trusted mortgage experts or financial planners that the homeowner has sought out, and who have legitimate credentials."