Are Reverse Mortgages Bad?

Are Reverse Mortgages Bad Finance Experts Pros Cons

You’ve likely seen ads on TV about how reverse mortgages can be the answer to all your financial woes. Well, if something sounds too good to be true, it just might be. So, are reverse mortgage bad? Let’s take a look at some pros and cons.

A reverse mortgage is money you borrow based upon the amount of equity in your home. Under the right circumstances, you don’t pay it back until you no longer occupy the property, either because you move out or because you die.

Homeowners who qualify for reverse mortgages are aged 62 or older, and the home is their primary residence. Homes that qualify are single-family homes or multi-family homes with up to four units. Some condominiums and manufactured homes that meet FHA standards also qualify.

With a traditional mortgage, the borrower makes payments to the lender. With a reverse mortgage, the lender makes payments to the borrower.

The homeowner may receive a one-time payment or regular monthly payments for a set period or for the duration of residence. Payment may also be a line of credit or any combination of these options.

Borrowers must pay property taxes, homeowners insurance, and maintenance costs.

To collect on the reverse mortgage, the provider of the reverse mortgage (the lender) gains title to the home and sells it. Any excess proceeds from the sale are passed on to the homeowner’s heirs.

Two Ways a Reverse Mortgage Could be a Good Option

There are really only two ways a reverse mortgage may be a good option:

  1. You have no intentions of moving.
  2. You’re not leaving your home to anyone in your will.

No Intention of Moving

Either as a steady stream or a lump sum, a reverse mortgage can be a valuable supplement to retirement income. It can help retirees — particularly those with limited retirement income — cover living expenses and other needs without having to sell their home and relocate.

But personal circumstances are unpredictable. Your health may deteriorate and require you to downsize, move in with relatives, or enter an assisted living facility. Repaying the reverse mortgage will be necessary in those cases. A personal loan may be a better short-term cash option if relocation is a possibility.

A reverse mortgage may also protect against declining home values. Reverse mortgages also have no impact on Social Security or Medicare.

Most seniors elect to receive monthly payments rather than a lump sum. You can use a reverse mortgage calculator to  get an idea of the amount you may be offered.

HECM ARM payment plans by borrower age group
This chart from Reverse Market Insight shows the reverse mortgage payment plans chosen by age group.

No Heir for Home

Preserving home equity for inheritance purposes isn’t as much of a concern if you have no heirs. In those circumstances, converting equity into cash may provide you additional financial resources during retirement.

A reverse mortgage can streamline disposition of the home if potential heirs do not want to inherit it, reliving those you leave behind from the need to deal with the property and any additional costs associated with preparing it for sale.

The most you can borrow is $625,000, although the actual amount depends on the home’s value, your age, and the current interest rates. Both lower interest rate and older age help increase the amount you can borrow.

Reverse Mortgage Pros and Cons

There are several pros and cons when considering a reverse mortgage. The pros and cons may vary based on the type of reverse mortgage in which you are interested.

Types of reverse mortgages

In addition to variances from the type of reverse mortgage, not everyone has the same lifestyle considerations. Make sure you weigh your individual pros and cons when deciding on the best way to move forward.

Pros:

  • Receive monthly payments: You’ll receive monthly payments for as long as you own and live in the property. This means you’ll continue to get payments even if you live to be 110 (and if you do, please tell us your secret!) as long as you don’t sell or move out of the house.
  • Supplement retirement income: Those monthly payments can be a crucial supplement to limited retirement income. Reverse mortgages convert home equity into cash, which can benefit retirees when pensions or Social Security may not provide the lifestyle they prefer.
  • No monthly mortgage payments: Reverse mortgages do not require monthly mortgage payments. The homeowners repays the loans when they sell their sell the home, move out permanently, or pass away. Not having monthly mortgage payments can significantly reduce financial strain.
  • Tax-free proceeds: Funds received through reverse mortgages are tax-free because the government considers them loan proceeds rather than income. The financial relief homeowners gain from reverse mortgages comes without increasing tax liability.
  • Retain home ownership: Borrowers continue living in their homes as long as they maintain their property, pay property taxes, and keep up with homeowners insurance.
  • Non-recourse lending product: Reverse mortgages are classified as non-recourse loans, meaning borrowers or their heirs will never owe more than the home’s value when the loan is repaid, regardless if the loan balance exceeds the home’s value. The non-recourse status of reverse mortgages can protect the homeowner’s other assets.
  • Hedge against market downturns: Reverse mortgage amounts don’t increase if the home’s value declines, which protects against housing market downturns.
  • Counseling required: Prospective reverse mortgage borrowers must undergo counseling from a federally approved agency to ensure they understand the fine print and can make an educated decision.

Cons:

  • High fees: Most of time, you’ll have to pay high, front-loaded fees, including an origination fee.
  • High interest: Usually, the interest rate on the loan is higher than those for regular mortgages, personal loans. or home equity loans. Every dollar spent on interest and fees eats away at the amount you receive.
  • Inheritance issues: You can’t bequeath the house to heirs unless you first pay off the reverse mortgage. The lender receives the house when you die. Unless you have left money in your estate that pays off the reverse mortgage, your heirs don’t get the house unless they first pay off the mortgage.
  • No relocation: If you move out, the loan becomes due. If the property ceases to be your residence for a year, you are considered to have moved out. So if you need to relocate to a long-term-care facility, you can trigger the loan repayment clause. In effect, you are a prisoner in your own home.
  • Still liable for other home costs: You still have to pay for home costs, such as taxes, HOA fees, utilities, insurance, etc. These costs soak up part of the payments you receive from the reverse mortgage.
  • Risk associated with accepting a lump sum payment: Typically, people who take reverse mortgages have no other sources of income besides Social Security. If you take a lump sum and then spend it all in the first few years, you’re out of luck.
  • Interest accumulation: The interest on a reverse mortgage adds to the loan balance and can significantly increase the amount owed. That reduces the equity available to borrower and heirs.
  • Risk of foreclosure: If you don’t continue to pay your property taxes and homeowners insurance and fail to maintain the home in good condition, the loan becomes due and payable, which can lead to foreclosure.
  • Impact on government assistance: Ironically, a reverse mortgage can affect eligibility for need-based government assistance programs such as Medicaid.

A Better Alternative May Be a Personal Loan

If you’re thinking that the cons outweigh the pros, you might be correct. Reverse mortgages are specialized lending products that for most homeowners are advantageous in limited circumstances.

A much better way to access quick cash is usually through a personal loan, which doesn’t come with any of the stipulations reverse mortgages have.

Before treading into the dangerous waters of reverse mortgages, you owe it to yourself to educate yourself and see if better alternatives are available.

Understand the costs and risks before proceeding. Consult a financial advisor and undergo mandatory counseling to make an informed decision that meshes with your financial needs and goals.