It is sometimes difficult to turn on the television these days without seeing a commercial for reverse mortgages. They feature older celebrities who extol the benefits of a guaranteed tax-free income for those homeowners aged 62 and older.
What they don't tell you is that reverse mortgages can also be dangerous and can put your biggest asset—your home—at risk, if you're not careful.
- A reverse mortgage can provide income to seniors based on the equity in their homes.
- Reverse mortgage contracts can have hidden costs such as fees and interest can eat up your home equity.
- Unless you are careful, you can risk losing your home or have it passed on to the lender when you die instead of to your heirs.
What Is a Reverse Mortgage?
The name is a bit confusing, but a reverse mortgage is nothing more than a regular mortgage except that the loan can be paid out to you in installments and you don't have to pay back a dime as long as you live in that home. In effect, you will have mortgaged the equity in your home, spending it down while interest accrues on the outstanding debt.
The money received from a reverse mortgage does not have to be repaid until you either leave the house, sell it, or die. At that time, the loan balance, interest, and accrued fees must be repaid in full, usually from the proceeds of the sale of the home.
This type of loan can be beneficial in a limited set of circumstances. It can provide a much-needed income supplement in retirement, for example. It can also help pay for medical or other unexpected expenses. In many circumstances, however, a reverse mortgage can be a risk to your financial security.
Below are six potential dangers to consider before signing on the bottom line.
Never sign on the bottom line immediately; take the time to review the contract and have it reviewed by a professional.
Each lender can offer slightly different products under the reverse mortgage banner. The rules and regulations involved are often complex and the loan contract 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 you sign.
Like the sale of any product when the salesperson is paid a commission, reverse mortgage pitches can be forceful and intense. Know the costs involved, both up-front and over the life of the loan.
A reverse mortgage provides the homeowner with an accessible pool of money that can often be used for any purpose. You can opt for a monthly payment as an income supplement, or you can make a phone call at any time and withdraw any amount you wish, or you can do both. You can even take it to the casino and gamble with it. Indeed, some are tempted to use the money unwisely.
Some use the funds as an investment pool, which on the surface seems like a smart idea. The risks of losses are obvious, but the on-going costs of the reverse mortgage can erase even good investment yields, leaving those borrowers at risk of losing their homes.
Federal law limits the amount due to the lesser of the total loan balance or 95% of the home's market value.
This is perhaps the greatest risk of a reverse mortgage: You cannot 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, say you have a serious health scare and spend three months in the hospital and in 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 move into an assisted living facility. The house must be sold and the reverse mortgage must be repaid.
Eligibility for Government Programs
Some government programs, such as Medicaid (but not Medicare), are based on the applicant's liquid assets. If you have reverse mortgage money, it may therefore affect your eligibility for some of these programs by turning illiquid home equity into liquid cash.
Before signing a contract, check with an independent financial professional to ensure that the cash flow from a reverse mortgage will not impact other funds you receive.
High Closing Costs
When considering taking equity out of your home, the loan origination and servicing fees must be taken into account. These fees may be buried in the loan documents and should be thoroughly reviewed.
Reverse mortgages can be an expensive way to tap into the equity in your home, so be sure to look at alternatives, such as a home equity loan.
Reverse mortgage contracts require immediate repayment on the death of the borrower. So if only one spouse's name is on the reverse mortgage contract, and that person dies, the house can be sold out from under the surviving spouse.
If repayment cannot be made from other estate assets, the house must be sold to repay the loan, leaving the spouse homeless.
The Bottom Line
A reverse mortgage can be a crucial source of emergency funds or an adequate income for seniors who would otherwise have to sell their homes to access their equity.
However, there are some dangers to these plans, and not all of them can be foreseen. Take the time to review the product and the pros and cons of using it as a source of funding. Never sign a reverse mortgage contract on the spot.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).