Trying to fund retirement can be a tricky business. From pensions and social security to investments and post-retirement employment, sifting through these endless options can often seem like a complex game of chance. In addition to these traditional income sources,seniors who own their home have yet another: the reverse mortgage.
Though largely unused by previous generations, choosing a reverse mortgage to fund your retirement and/or maintain your home as you age is a viable option for many people ages 62 and older. However, unlike income-earning activities, reverse mortgages are really just repackaged loans. And all loans must be repaid eventually.
Seniors considering the benefits of a reverse mortgage need to carefully consider not only what they gain from the process (more money in their pockets) but the real and potentially devastating drawbacks that come down the line from this type of loan. There are, in fact, several negatives to taking a reverse mortgage that you need to consider completely before signing on that dotted line.
What Is a Reverse Mortgage?
A reverse mortgage is first and foremost a loan. Like its name implies, it is a available only to homeowners and designed as a means for extracting equity from the home. However, unlike with a home equity loan or home equity line of credit (HELOC)there is no monthly mortgage payment attached to a reverse mortgage.
In effect, a reverse mortgage is switching or“reversal” if you will, of the roles ofthe lender and the lending institution. Rather than make a monthly payment to pay back a loan used to purchase a home or one secured by that home, the bank or lending institution pays you. By doing so, the bank, in effect to buys equity in your home, while you retain ownership.
The balance of the reverse mortgage loan is not due until one of two events occur, you move out or die. At this pointthe bank puts the house up for sale as a foreclosure and uses the monies acquired from itssale to cover thebalance due onthe loan, including its interest and any fees rolled into the initial principal amount. If they sell the home formore money than that total due, the difference is paid out to you or your heirs. Further, because this is a type of “non-recourse” loan, insuredby the FHA, if the amount due exceeds the assessed value of the home, neither you noryour heirs must pay the difference.
5 Negative Effects of a Reverse Mortgage
Because ofthe seeming simplicity of a reverse mortgage – get money now, don’t pay it back until you die – many older adults consider it a really easy and logical way to fund retirement or pay for unexpected expenses such as home repairs or medical bills. However, there is danger lurking just beneath the surface of the reverse mortgage loan. In fact, there are a number of truly negative effects associated with this type of loan that anyone considering one must carefully consider before taking the leap.
1. You Might Not Get That Much Money
While, at first, getting some or all of the value of your home back in a reverse mortgage seems great, the truth is that qualifying is not as easy as it seems. Plus, even ifyou do qualify, you may end up with a lot less money than you’ve planned. The basics required by the FHA to receive an insured reverse mortgage, also known as a Home Equity Conversion Mortgage (HECM) are that all borrowers must be a minimum of 62 years old andmust own, or owe very little, on their currentmortgage. Those with a current mortgage must use the HECM must pay the balance owed.
Furthermore, how much money you can even get from a HECM depends on different factors than other loans (which rely on income and credit to determine a principal). A reverse mortgage actually pays out more money based on age (older people qualify for more) and the value of your home (up to $625,500), and your qualified interest rate.
2. You Must Pay Very High Fees and Interest
A reverse mortgage loan generally carries a higher interest rate than the advertised rate for mortgages or even home equity loans. These higher rates lead to lower principals since lenders need to leave space in the home’s value for interest to accumulate since you will not be making any payments on the loan other than what can be gained by the sale of the home.
Reverse mortgages also come packaged with a number of up-front fees and insurance payments that roll into the loan amount and drive down the principal. Many homeowners are surprised to discover that the fees tacked onto a HECM can easily cost tens of thousands of dollars.
3. Your Home May Not Stay in the Family
By taking a reverse mortgage, you are actually diminishing your own equity in your home by allowing the bank to place a lien on the property. Upon your death, your heirs will need to either pay that lien or take out a mortgage themselves in order to maintain ownership. If you had your heart set on keeping a home “in the family” or passing property onto your heirs, then a reverse mortgage can make doing so much more difficult.
4. This Home Must Remain Your “Primary Residence”
While you may not have any plans to move out of your home, life can change. As they get older, many adults find that they need assistance in the form of family members who live close by or even professional assisted living facilities. If you are forced to move for health or other purposes, after 12 months the balance of your reverse mortgage loan will be due.
For older people who need medical care, this payment can represent a particular hardship since, often, they need all the money they can get to finance their illness.
5. You Need to Maintain the Home
As part of the reverse mortgage loan agreement, all borrowers pledge to maintain the home in good repair – which means paying for that maintenance, as well as keep up-to-date on taxes and homeowners insurance. If your source of income is insufficient to cover these expenses, even without the burden of a mortgage as well, then a reverse mortgage will do little to help over the long term.
Is There a Silver Lining?
The value of a reverse mortgage, like any financial product or decision, varies according to situation. There are thousands of people who take these loans each year and go on to lead happy, fulfilling lives as a result. In fact, for the right borrower the relief gained from eliminating a mortgage payment and the flexibility of added funds is enough to justify the decision.
Ultimately, talking to your financial advisor as well as your family is important before starting the reverse mortgage process. You must also maintain that communication throughout the remainder of your life in your home. This is critical to make sure that everyone is prepared for the consequences of thedecision to take a reverse mortgage.
