Millions of baby boomers are nearing retirement without having set aside sufficient funds in their IRA’s, 401k’s or other retirement savings accounts. For many, home equity will be their main retirement savings vehicle.

But tapping home equity to pay living expenses isn’t a simple matter. The traditional method is to sell the home, downsize or rent, and use home sale proceeds for living expenses. Home equity loans or lines of credit (HELOC) are another option, but require monthly loan payments – at a point in life when income is limited.

A third option rapidly growing in popularity is the reverse mortgage. A reverse mortgage allows senior homeowners (age 62+) to extract the equity in their homes without having to sell or make monthly loan payments.

Unlike a regular mortgage where payments are made to the lender, in a reverse mortgage, the homeowner receives money from the lender but doesn’t have to pay it back for as long as they live in the home. Instead, the loan is repaid when the homeowner dies, sells, or no longer lives there as a principal residence. Reverse mortgages can help homeowners who are house-rich but cash-poor stay in their homes and still meet their financial obligations.

But reverse mortgages can be quite expensive due to typical mortgage closing costs and the special type of mortgage insurance that is the backbone of the reverse mortgage program. The most popular type of reverse mortgage – the home equity conversion mortgage or “HECM” – is insured by the federal government. This insurance guarantees that no matter how long the homeowner lives and ends up borrowing, the total amount owed will never exceed the market value of the home. Other types of reverse mortgage, such as the Fannie Mae HomeKeeper, have similar guarantees.
Because of the high costs, reverse mortgages are not a good choice for every senior homeowner. Each homeowner’s situation and needs are, of course, unique, but there are some general guidelines that can be used to help determine if a reverse mortgage will be a prudent financial move:

Age and Health – The amount that can be borrowed through a reverse mortgage is largely based on the age and life expectancy of the homeowner. The younger the homeowner, the smaller the amount that can be borrowed. The average HECM borrower is 74 – 75 years old and, in general, this is the best age (“not too old; not too young”) for a reverse mortgage.

Future Plans – If there is a reasonably good chance the homeowner will need to sell in less than seven years, the up front costs will make the reverse mortgage an extremely expensive forma of borrowing. The longer the homeowner stays in the home, the more a reverse mortgage makes sense.