For a retiree on a finite budget, carrying multiple debts that require monthly payments can feel like swimming against the current. Especially when high interest rates mean those monthly payments don’t meaningfully cut into the principal owed. Whether you have high-interest credit card and automotive debt or no-interest medical debt, if your monthly payment obligations are taxing the limits of your monthly budget, a reverse mortgage may offer some breathing room.
A reverse mortgage loan is also a type of debt that will eventually need to be paid back. However, unlike loans that require monthly payments, a reverse mortgage balance isn’t due until the end of the loan. At that time, the amount due will include the principal plus interest that has accrued and compounded over the life of the loan. Here’s more about how reverse mortgages work and how using one to pay down other debts may work in your favor. We’ll also discuss the tradeoffs and risks involved with using a reverse mortgage to consolidate debts.
How a reverse mortgage works
A reverse mortgage is a loan that senior homeowners can use to borrow against the equity in their home. The minimum qualifying age depends on the type of reverse mortgage. Proprietary reverse mortgages can be available to people as young as 55, depending on the loan product and state regulations. Home equity conversion mortgages, also known as HECMs, are government-insured reverse mortgages available to homeowners 62+.
While many consumer loans, including credit cards, require the borrower to start paying them back immediately, reverse mortgages work differently. Borrowers with these loans don’t need to pay them back until a maturity event brings their loan to an end. In other words, borrowers aren’t required to pay back reverse mortgages in monthly installments. Maturity events include the borrower failing to uphold the terms of the loan or leaving the home permanently by passing away, or for another reason.
While borrowers no longer make monthly mortgage payments, the loan terms require them to maintain their homes and continue paying other home-related expenses. These include insurance and any other fees or dues associated with homeownership. Additionally, though loan proceeds are not taxed as income, reverse mortgage borrowers are still responsible for paying their property taxes.
How a reverse mortgage can help manage debt
A reverse mortgage is a loan and, therefore, a debt. However, it can offer a way of restructuring other debts that may improve a borrower’s overall financial position and outlook on retirement. The most obvious reason to pay off higher-interest debts with a reverse mortgage (or any other loan, for that matter) is if you are able to secure a lower interest rate, ensuring a lower output over the life of the loan. But even if the reverse mortgage loan has a higher interest rate than the debt or debts you’re carrying, the absence of monthly payments may make the trade worthwhile by increasing your monthly cash flow.
Key advantages of using a reverse mortgage to manage debt include:
- Immediate relief. People struggling to keep up with monthly payments will find the removal of those payments eases both their budgets and their mental state.
- Increased cash flow. Without the onus of multiple monthly payments eating into their budgets, people find they can focus on building up a cash repository and enjoying their lives.
- Reduced Stress. Juggling fewer loans and payments reduces stress and helps contribute to overall well-being.
- Improved financial control. Managing fewer immediate financial obligations means borrowers can focus on making better financial choices for their futures.
What can borrowers use reverse mortgage proceeds for?
Reverse mortgage proceeds can be used for virtually anything a borrower needs. One common use of proceeds is managing outstanding higher-interest debts like credit cards that are putting stress on monthly budgets and cash flow. Other types of debt that reverse mortgage proceeds can help pay off include medical debts, student loans, auto loans, and existing mortgages.
What are the downsides of using reverse mortgage proceeds to pay down other loans?
Many people find the release of stress that comes with removing the burden of multiple creditors and loan payments to be a worthwhile tradeoff for the additional cost and interest charged on a reverse mortgage. However, before making this trade, it is important to understand what you are agreeing to and its impact on your heirs and estate.
Reverse mortgages aren’t free
Unlike some of the debts we’ve discussed in this article, in addition to interest on a reverse mortgage, a borrower pays upfront fees to take the loan. Home equity conversion mortgages (HECMs) or government-insured reverse mortgages require borrowers to pay monthly mortgage insurance premiums in addition to other costs specified in the terms of the loan.
Reverse mortgages are loans secured by your home
Using a reverse mortgage to pay down other debts can offer immediate financial relief. However, the debt does not go away. Interest will continue to accrue and compound on the loan balance until the loan comes due. This means that the final loan balance will likely exceed the amount borrowed. The fact that the loan is secured by the home means that borrowers who do not meet the loan terms risk foreclosure on their homes.
Impact on inheritance
When a reverse mortgage comes due, the balance is often equal to or greater than the value of the home. Though heirs will never be saddled with additional debt, they will need to pay the loan balance, which often means selling the home to pay off the loan.
Home Equity Conversion Mortgages (HECM) and many proprietary reverse mortgages are non-recourse. This means heirs who will never owe more than the value of the home. Though they will not owe more than the home is worth, if leaving your home to your children is important to you, then this may not be the best solution for resolving other debts.
Plan for success
Before deciding to use a reverse mortgage to pay off or down other debts, it’s essential to have a financial plan that accounts for the costs of the reverse mortgage and a budget that will ensure you are able to spend responsibly moving forward. Any decision about using a reverse mortgage to pay off other debt, especially low-interest debt (like medical debt), should consider the long-term costs of holding the loan and weigh those costs against the short-term advantages of taking the loan.
Whether you decide to get a reverse mortgage or not, a finance professional can help you strategize and make a plan that makes sense for you and your situation.
