Reverse mortgages are a way for older homeowners to draw an income (either in installments or a lump sum) against the equity that they've built up in their homes.
For many seniors in need of funds to live on, it is nothing short of a blessing, but there are some pitfalls to the process that anyone considering it should ponder. Find out what you need to know before taking the reverse mortgage plunge.
- Beware of high costs when considering a reverse mortgage, which can drain your home equity.
- If you cannot repay the loan upon your death, your kids might not inherit the family home; rather, it will be handed to the lender.
- Reverse mortgages could increase your liquid assets, potentially reducing availability of Medicaid benefits.
Beware of High Costs
The majority of reverse mortgages, known as Home Equity Conversion Mortgages (HECMs), are insured by the federal government and are available through Federal Housing Authority (FHA) lenders. Reverse mortgages come with an array of fees. Some are paid upfront, like your appraisal fee or credit report fee; others are paid over time, like your mortgage insurance premium or your servicing fee. Here's a look at the costs that can nibble away at the income you'll receive from a reverse mortgage.
- Third-party charges: Closing costs from third parties can include an appraisal (average price is $450, but can be much higher depending upon location), title search (varies by loan amount and region), insurance, surveys, inspections, recording fees, mortgage taxes, credit checks, pest inspection (about $100), flood certification fee ($20-$30) and other fees.
- Origination fee: The origination fee compensates the lender for processing your HECM loan. The fees vary from lender to lender but are capped by the FHA. For homes that are valued at $125,000 or less, the origination fee is capped at $2,500. For homes that are valued over $125,000, the lender may charge up to 2% of the first $200,000 and 1% on the value of the home over $200,000, for a maximum of $6,000.
- Mortgage insurance premium: You will also incur a cost for FHA mortgage insurance. The mortgage insurance guarantees that you will receive expected loan advances. You can finance the mortgage insurance premium (MIP) as part of your loan.
- Servicing fee: Lenders or their agents provide servicing throughout the life of the HECM and are paid servicing fees in return. Servicing includes sending you account statements, disbursing loan proceeds, and making certain that you keep up with loan requirements such as paying real estate taxes and hazard insurance premiums. Lenders may charge a monthly servicing fee of no more than $30 if the loan has an annually adjusting interest rate or has a fixed interest rate, and no more than $35 if the interest rate adjusts monthly. At the loan closing, the lender sets aside the servicing fee and deducts the fee from your available funds. Each month the monthly servicing fee is added to your loan balance. Lenders may also choose to include the servicing fee in the mortgage interest rate.
Given the substantial up-front costs associated with the process, homeowners in need of liquidity who are considering selling their homes within the next several years would probably be better off applying for a more traditional line of credit, a home equity loan, or a personal loan.
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).
Your Kids Might Not Inherit the Family Home
Parents often want to pass the family home to the next generation. However, when a reverse mortgage is taken out, even though the lending institution does not take title to the home, the mortgagee has an obligation to pay back the loan according to the terms of the agreement. In many cases, that repayment is made by selling the home and then turning over the proceeds (or a portion of them) to the bank.
As a possible workaround to avoid selling the family home, some families will take out an insurance policy on the homeowner and make an adult child or the lending institution the beneficiary. Using this strategy, the bank may be repaid without having to sell the property upon the homeowner's death. Consider consulting with an insurance agent to determine the best way to ensure that proceeds from such a policy are sufficient to satisfy the outstanding loan.
Reverse Mortgages May Impact Medicaid Benefits
Lending institutions are quick to say that obtaining a reverse mortgage will not affect one's Medicaid payments, but for this to be true, the loan must be structured very carefully. A lump-sum payment, for example, will count as an asset that you would need to spend down before you would be eligible for Medicaid payments.
However, according to LongTermCare.gov, from the U.S. Department of Health and Human Services, "As long as you spend the payments you receive in the month that you receive them, the money is not taxable and does not count towards income or affect Social Security or Medicare benefits." Such payments also do "not count as income for Medicaid eligibility."
LongTermCare.gov also notes that if the total liquid resources are more than $2,000 for an individual or $3,000 for a couple, this could make someone ineligible for Medicaid. However, if you receive monthly payments that you spend on your ongoing expenses and don't accumulate savings, you may be all right.
Individuals currently receiving—or who anticipate receiving—Medicaid should consult an accountant and a financial advisor in order to make certain that they are aware of all of the potential ramifications of taking out a reverse mortgage.
Other Potential Pitfalls
While the lending institution may not go after your heirs for money, nor is it entitled to take more than the appraised value of your home, there are several items usually located in the fine print of these contracts that may raise alarm bells.
- You could be forced to sell. Some reverse mortgages have clauses that state that the loan must be repaid if the last surviving borrower permanently moves out of the home. This raises the concern that you could (hypothetically) be in the hospital receiving treatment for a medical condition and be released to find that your home is in foreclosure. In fact, you'd have to have lived somewhere else (such as a nursing home or assisted living facility) for more than 12 consecutive months—a situation that counts as a "permanent move" and can trigger the requirement to sell your home.
- You are responsible for other payments. Because homeowners remain responsible for all taxes, insurance, and upkeep on the home, failure to pay taxes or maintain adequate insurance could cause the loan to be called in.
- You might get less than you expected. Keep in mind that the property is subject to an appraisal. So, while you might have put large sums of money into your home over the years, there is the chance that it's worth less than you paid for it. As a result, the proceeds that you receive as part of the reverse mortgage process may be less than you anticipated.
The Bottom Line
Reverse mortgages are a great way for older homeowners tap into the equity in their homes, either in installments or in a lump sum. However, it is critical to be aware of the potential downsides before entering into such an agreement.