Someone who turns 65 has an almost 7-in-10 chance of needing long-term care in the future, according to the Department of Health and Human Services, and many don’t have the savings to meet the costs of assisted living. But they may have a mortgage-free home — and the equity in it, giving them the potential option of a reverse mortgage to help pay for care costs.
How to assess if a reverse mortgage could be a good option and know the pitfalls.
What is a Reverse Mortgage?
A reverse mortgage is a loan or line of credit on the appraised value of your home. Most reverse mortgages are federally backed Home Equity Conversion Mortgages, or HECMs, which are loans up to a federal limit of $970,800. Homeowners must be 62 years old to apply.
If you have at least 50% to 55% equity in your home, you have a good chance of qualifying for a loan or line of credit on some of that equity. How much you have available depends on your age and the estimated value of the home. You still have to pay taxes and insurance on the home, and the loan will be repaid if the borrower dies or moves out. With two borrowers, the line of credit lasts until the second borrower dies or moves out.
A reverse mortgage is a non-recourse loan, which means that if the loan amount exceeds the value of the home, the borrower or heir does not have to pay more than the loan amount owed or the price for which the home could be sold.
Can you use it for long term care?
A reverse mortgage can be a crucial income stream to pay for long-term care, but there are some caveats.
For example, a reverse mortgage requires you to live in the house. If you are the sole borrower of a reverse mortgage and have to relocate to a nursing facility for a year or more, you are in breach of the loan requirements and will have to repay the loan.
Because of the cost, reverse mortgages are also best if you plan to stay in your home for the long term. They don’t make sense if your home isn’t suited to aging in place or if you’re planning to move in the next three to five years, says Marguerita Cheng, a certified financial planner in Potomac, Maryland.
But for home health care or paying for a second borrower who is in a nursing home, home equity can help bridge the gap.
Advantages of a reverse mortgage
- You tap into an “up” asset. “Most people will find that their home is the only asset they value this year, and that makes it a good source of income,” says Byrke Sestok, a CFP in Harrison, New York.
- You can save the value. If you think you will have trouble meeting future care needs, you can take out a reverse mortgage now when property values are high.
- The income is tax-free. Any funds you withdraw from your reverse mortgage line are tax-free and will not affect your Social Security or Medicare benefits.
Disadvantages of a reverse mortgage
There are downsides to using your home’s equity to cover expenses.
- They’re expensive. Obtaining a reverse mortgage costs about the same as obtaining a traditional mortgage — expect to pay around 3% to 5% of the home’s appraised value. However, you may be able to transfer the cost to the loan.
- You have to pay interest. Interest accrues on every part you used, so you end up owing more than you borrowed.
- You leave the heirs less. The more you use, the less you’ll leave behind.
The question of whether you can use your home equity as a source of income can be complicated and depends on your other assets and plans for the future. A financial planner can help you figure out the numbers.