Why Downsizing is Better Than a Reverse Mortgage

by TTMK on November 22, 2014 · 2 comments

As older adults near retirement age, most begin taking a closer look at their expenses in an effort to determine whether they have saved enough for retirement, and where they can make adjustments to ensure that their savings will carry them through their golden years. One area that’s often of great concern is housing, or more specifically, what living arrangement makes the most financial sense.

One option that is growing in popularity is the reverse mortgage, a product being marketed to older Americans (over age 62) who are looking for ways to ensure that they have enough income after they retire. A reverse mortgage is exactly what it sounds like: Instead of the homeowner making payments to the bank and building their ownership in the home until they have repaid the entire debt, the bank makes a payment to the homeowner each month based on the equity in the home.

For example, say that a homeowner purchased a home in the 1970’s for less than $100,000. Since then, the home has appreciated to nearly three times the purchase price. One option would be for the homeowner to sell the property for its current value and move out. A reverse mortgage, on the other hand, allows the homeowner to stay in the home while receiving payments for it from a mortgage company, until he or she dies.

When someone wants to stay in his or her home, or selling isn’t practical, a reverse mortgage can seem like a good deal. However, when you take the emotional component out of the equation, in the vast majority of cases, downsizing to a smaller, more affordable home almost always makes more financial sense, according to experienced wealth advisors.

The Benefits and Drawbacks of a Reverse Mortgage

The major benefits to a reverse mortgage are immediately apparent: The homeowner gets to live in the home that he or she may have lived in for decades, and the home becomes a source of income. However, the benefits end there. One of the major drawbacks of a reverse mortgage is that once the homeowner dies, his or her heirs must relinquish the property to the bank, or refinance the loan to effectively “buy back” the home.

There are other downsides as well. Under the terms of a reverse mortgage contract, the homeowner is still responsible to pay the taxes and insurance. If they are unable to do so, they could face foreclosure. A reverse mortgage also prevents a homeowner from using the equity in their home to cover the cost of long-term or nursing care should they need it. In addition, a reverse mortgage doesn’t address some of the issues of staying in an existing home, such as maintenance, upkeep, or high utility costs. Even with the money coming in from the “new” owner, it may not be enough to cover all of the home expenses, or the help needed to take care of issues.

Why Downsizing is Better

While selling your home and moving isn’t always comfortable emotionally, in the end, it may be the better financial decision.

When you hit retirement, there is a good chance that you have built a significant amount of equity in your existing home, or even have paid it off entirely. Selling your home will most likely result in a profit that can then be used toward the purchase of a more affordable home, and in some cases, even a surplus that can be used toward your retirement fund after taxes. You will have to pay at least some of the value of your home in closing costs and fees, but you will not only gain the proceeds from the sale, but the equity in your new home should you choose to purchase another property. This equity can be passed on to your heirs after your death, unlike in a reverse mortgage, where your heirs lose that asset. In addition, downsizing usually means reducing expenses in other ways (utilities, maintenance, etc.).

Of course, if you are already in the right home and have enough resources to cover your expenses throughout retirement, the question of whether to downsize or take out a reverse mortgage may be moot. If you need to make a decision, consider downsizing first. Once you take out a reverse mortgage, it can be costly to try to sell your home and move, so it’s essentially a permanent arrangement. For the most flexibility and value for your money, settling into a smaller home is usually the better option. 

{ 2 comments… read them below or add one }

Jon @ Money Smart Guides November 24, 2014 at 6:36 am

Good counterpoint to a reverse mortgage. At the end of the day, I think it is best to list all of the advantages/disadvantages of each choice and then run the numbers to see which one makes the most sense. That is the only way you will be able to come up for the right decision for your personal situation.

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Little House November 24, 2014 at 10:11 am

A reverse mortgage has always sounded shady to me. What happens if the homeowner out-lives the reverse mortgage payments? Could that happen? I think selling the home and using the profits to purchase a smaller house makes more sense. I know my in-laws are thinking of doing this to reduce the amount of wasted space and cleaning! Who wants to continue cleaning a 2,000 sq. ft. house when it’s just the two of you and your joints hurt!?

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