It's difficult to turn on the television these days without seeing a slew of commercials for reverse mortgages. They feature past-their-prime celebrities such as Henry Winkler and Fred Thompson, extolling the benefits of "guaranteed tax-free income" for those 62 and over. What they don't tell you is that reverse mortgages can be dangerous and can put your biggest asset - your home - at risk.
A reverse mortgage really a misnomer. It is really nothing more than a regular mortgage, except that the loan proceeds are paid out to you in installments, rather than all at once. These plans mortgage the existing equity in your home, bleeding it down while it accrues interest on the growing debt. This mortgage does not have to be repaid until you either sell the home or die. Then the loan balance, interest and accrued fees are extracted from the sale proceeds. This type of loan can be beneficial in a very limited set of circumstances, such as allowing a senior to remain in his or her home, rather than having to sell it to pay for medical or other unexpected expenses.
In many circumstances, however, a reverse mortgage can be a risk to your financial security. Here are six dangers you should consider before signing on the bottom line.
Each lender offers slightly different products under the reverse mortgage banner. The rules are often complex and the contract you sign can be full of hidden landmines. The program will outline fees and interest, along with rules for repayment or default. Regardless of what the salesperson says to you verbally, have a lawyer review the contract and explain it to you in plain English before signing.
Like the sale of any product where the salesperson is being paid a commission, reverse mortgage pitches can be forceful and intense. Some financial planners tout reverse mortgages as a way to fund investments, such as annuities. The costs of the reverse mortgage, however, may completely erase any benefit of investing in other products, leading borrowers to risk losing their homes. Lenders cannot force you to use your reverse mortgage proceeds for any particular purpose. It pays to have some time to consider the product and the pros and cons of using it as a source of funding. Never sign a reverse mortgage contract on the spot.
This is perhaps the largest risk of a reverse mortgage. You can't predict the future. Reverse mortgages come with stipulations about which circumstances require immediate repayment or foreclosure on the home. Some outline how many days or months the property can sit vacant before the lender can call the loan. For example, if you have a heart attack and spend three months in hospital and residential rehabilitation, the lender may be able to call the loan and foreclose on the house because it is unoccupied. The same is true if you have to go into an assisted living facility. The reverse mortgage must be repaid or the house must be sold.
Eligibility for Government Programs
Certain government programs, such as Medicaid, are calculated with reference to your total liquid asset base. If you have reverse mortgage proceeds that you haven't yet spent, they may affect your eligibility for some of these plans. Before signing a contract, check with an independent financial professional to ensure that the cash flows from a reverse mortgage won't impact other funds you receive.
When considering taking equity out of your home in the form of a reverse mortgage, all of the loan origination and servicing fees must be taken into account. Many of these fees can be buried in the expansive loan documents and should be thoroughly reviewed before signing the contract. Reverse mortgages can be a very expensive way to tap into the equity in your home, so be sure to look at other alternatives, such as home equity loans, if you qualify.
In cases where only one spouse's name is on the reverse mortgage contract, the house can be sold out from under the other spouse if the borrower dies. All reverse mortgage contracts require immediate repayment on the death of the borrower. Federal law limits the amount due to the lesser of the total loan balance or 95% of the home's market value. If repayment cannot be made from other estate assets or other assets of the spouse, the house must be sold to repay the loan, leaving the spouse homeless.
The Bottom Line
Reverse mortgages can be an important source of emergency funds for some seniors who would otherwise have to sell their homes to access their equity. There are several dangers to these plans, however, that can put your home at risk and sap your asset base.