Reverse mortgages can be a good way for seniors to access the money tied up in their home. A reverse mortgage is a loan for homeowners who are 62 or older and have considerable home equity. It allows these seniors to borrow money against the value of their home and receive funds as a lump sum, fixed monthly payment, or line of credit. The entire loan balance becomes due and payable when the borrower dies, moves away permanently, or sells the home.
If you think that sounds like an attractive proposition, you’re not alone. Reverse mortgages are also becoming more popular, with 43,000 issues in 2020 (the most recent statistics available). That was a 23% increase from the year before.
You should be aware, however, that reverse mortgages come with risks, obligations, and costs—and that sometimes these are hidden or hard to calculate before you finalize your reverse mortgage. In this article, we’ll take you through five of these issues.
There are three types of reverse mortgages. The most common is the home equity conversion mortgage (HECM). The HECM represents almost all of the reverse mortgages that lenders offer on home values below $970,800, so that’s the type that this article will discuss. If your home is worth more, however, you can look into a jumbo reverse mortgage, also called a proprietary reverse mortgage.
- Sometimes the risks, obligations, and costs of a reverse mortgage are hidden or hard to calculate before you finalize your reverse mortgage.
- Lenders that use high-pressure sales tactics can be a red flag.
- There are lots of extra fees, which are often rolled into the loan, so they are not immediately apparent.
- You should add your spouse as a co-borrower where appropriate.
- A reverse mortgage does not mean your expenses end: You must keep paying property tax and homeowners insurance or you could face foreclosure.
- Other ways of accessing your home equity might be more cost-effective in the long term.
Some Lenders Use High-Pressure Sales Tactics
The first thing you should know is that reverse mortgages have a reputation for attracting predatory practices and lenders. Some seniors have been targeted with high-pressure sales tactics on reverse mortgages. You should be especially skeptical if a salesperson gives you suggestions about how to spend the money from your reverse mortgage, particularly if they suggest putting the money into another financial product.
That doesn’t mean that a reverse mortgage is always a bad idea, though. For many people, a reverse mortgage can be a good way of providing themselves with a regular, dependable income in retirement. Just make sure you understand all of the complexities of the mortgage you take out.
Reverse Mortgage Fees Are High
The costs you will pay to take out a reverse mortgage can be very high compared with other forms of borrowing against your home equity. Borrowers must pay an origination fee, an upfront mortgage insurance premium, ongoing mortgage insurance premiums (MIPs), loan servicing fees, and interest. The federal government limits how much lenders can charge for these items, but the origination fee, in particular, can be high—it’s capped at $6,000.
These fees might not be immediately obvious to seniors contemplating a reverse mortgage, because they are often paid from the money you borrow. That means that you won’t necessarily receive the money and then have to pay it to the lender, which can hide the fact that you are paying it. In practice, this process means that fees and interest are taken out of your home equity.
Make sure you understand the residency rules of reverse mortgages and your other obligations. If you move away from your home for more than 12 consecutive months, even for medical reasons, you may be forced to sell your home. Similarly, your lender may foreclose on you if you fall behind with your homeowner’s insurance premiums.
You Should Add Co-Borrowers
It’s also important to pay attention to the residency rules when you take out a reverse mortgage. A reverse mortgage must be taken out against your principal residence, which is the place where the spend the majority of the year. If you leave this residence for six or 12 consecutive months, even if for medical reasons, your lender may end your reverse mortgage and demand that you sell your home to pay off your debt.
This can be a particular problem for married couples who live together, but only one of whom has their name on the reverse mortgage documents. In this case, the spouse may be forced to sell their home to pay back this debt while they are still living in it. To avoid this outcome, you should make sure that you add your spouse as a co-borrower, or at least make sure you can prove they qualify as an eligible non-borrowing spouse.
You Have Obligations
When you are working out whether a reverse mortgage can support you in retirement, you should factor in the cost of property tax and homeowner’s insurance. Most reverse mortgage lenders require borrowers to stay up to date on both of these. That’s because your house is their collateral for the loan, and if it is damaged it may not sell for the fair market price, and that means the lender won’t get their money back.
In other words, after taking out a reverse mortgage you will have obligations to your lender. And if you don’t fulfill them, your lender may foreclose on your loan. This is a real issue with reverse mortgages. In recent years, according to a 2019 Brookings Institution paper on reverse mortgages, 18% of reverse mortgages ended in foreclosure. Sometimes it's because the property taxes hadn’t been paid. but most often it was because the homeowners no longer lived in the home.
There Are Other Options
Understandably, a lot of reverse mortgage lenders won’t tell you that there are other—and potentially cheaper—ways of accessing the equity you’ve built up in your home.
These alternatives include:
- A cash-out refinance: If you’re looking to access a large amount of home equity at once, a cash-out refinance can help with that. Doing this will mean you must make monthly payments to a lender. However, in the long term, you may preserve more of your equity compared to a reverse mortgage.
- A home equity loan or a HELOC: A home equity line of credit (HELOC) provides homeowners access to home equity. Unlike a reverse mortgage, home equity loans and HELOCs require borrowers to make payments. On the other hand, they may come with fewer fees and can be a less expensive alternative to a reverse mortgage.
The best option for you will depend on your reasons for seeking a reverse mortgage. Contacting a HUD counselor can be useful if you are still unsure what to do.
What Are the Downsides of Getting a Reverse Mortgage?
Mainly the costs. Reverse mortgages have expenses that include lender fees (origination fees are capped at $6,000 and depend on the amount of your loan), FHA insurance charges, and closing costs. These costs can be added to your loan balance; however, that means you will have more debt and less equity.
Do Reverse Mortgages Take Advantage of Seniors?
Sometimes, but not always. There have been reports that reverse mortgage lenders have targeted the elderly with aggressive sales tactics. However, for some seniors a reverse mortgage can be a great way to unlock the value of their home and provide a reliable source of income in retirement.
How Much Money Do You Get From a Reverse Mortgage?
The proceeds that you’ll receive from a reverse mortgage will depend on the lender and your payment plan. For a HECM, the amount that you can borrow will be based on the youngest borrower’s age, the loan’s interest rate, and the lesser of your home’s appraised value or the FHA’s maximum claim amount, which is $970,800 as of Jan. 1, 2022.
The Bottom Line
A reverse mortgage can be a good way for seniors to access the equity they have built up in their home. However, reverse mortgages may have hidden costs and obligations. It’s important to understand these before you agree to anything.