For seniors struggling with expenses, a reverse mortgage may appear to be a practical option. Though such a lifeline seems appealing, a closer look may say otherwise. The industry is rife with scams; fees are high and often hidden. In addition, reverse mortgages may have variable interest rates, so you may wind up owing more over time.
What Is a Reverse Mortgage?A reverse mortgage is a lending option that allows homeowners to tap into home equity to free up cash for living expenses, medical expenses, or other needs.
Three types of reverse mortgage are available: single-purpose, federally insured, and proprietary. The most common is the federally insured home equity conversion mortgage. The term "reverse mortgage" is commonly used to refer to this type of mortgage, and that is what this article will discuss.
When a Reverse Mortgage Might Make SenseA limited number of homeowners meet the criteria for a reverse mortgage. For those who do, it can be an attractive option, for a few reasons:
Unlike distributions from a retirement account such as a 401(k), the IRS does not treat reverse mortgage funds as income; thus they are not taxable.
Why it Almost Always Doesn’t Make SenseWhile there are some positive attributes to reverse mortgages, the bad tends to outweigh the good for most people.
Compound InterestThe interest from a reverse mortgage accrues monthly and is added to the balance. In other words, each month the homeowner is charged interest and fees—on the interest and fees that were added to the previous month's loan balance.
Strict GuidelinesLenders may hold borrowers to strict home maintenance standards to protect the resale value of the home. Failing to adhere to loan terms, such as not adequately maintaining the home, or neglecting property taxes, may force the borrower to pay off the mortgage early.
Reverse mortgages include other strict guidelines for homeowners and their heirs. If a borrower moves out of the residence or stops living in the home for longer than a year, before the loan is repaid in full, the loan will need to be repaid.
Non-Borrowing SpousesMarriage complicates reverse mortgages. If your spouse has a reverse mortgage, and dies or moves out of the home, what happens next depends on whether you are a co-borrower on the loan, or an eligible or ineligible, non-borrowing spouse.
If both spouses were at least 62 and co-borrowers, the spouse who remains in the home will continue receiving funds from the reverse mortgage, if applicable.
If the remaining spouse is not a co-borrower, but is an eligible spouse (married to the borrower at the time the borrower applied for and closes the loan) the reverse mortgage will be put into deferral. This means the eligible spouse can continue living in the home, and will be responsible for the conditions of the reverse mortgage. However, the eligible spouse will not receive reverse mortgage funds.
Predatory ScamsThe reverse mortgage industry is rife with fraud. In fact, reverse mortgage scams are one of the top scams the AARP warns its members about. Predatory lenders prey on cash-strapped seniors.
Costly Fees and Mortgage InsuranceReverse mortgages are often littered with costly fees. Origination fees, service fees, and mortgage insurance premiums can snowball into exorbitant costs.
Costly Interest PaymentsThe majority of reverse mortgages have a variable interest rate. This means that the interest rate can increase over time, which exacerbates the cost of the loan.
Reduced EquityWhile a reverse mortgage borrows against a home's equity, it can also reduce it. If you are counting on your home to be a large factor in your family's inheritance, you may want to think twice.
Avoid the Dilemma AltogetherA problem can be solved with a solution. However, a dilemma is a difficult choice between two or more alternatives. Taking out a reverse mortgage should not be seen as a solution but as a dilemma.
The best course is to make changes before the situation becomes desperate. Alternatives include home equity loans, refinancing, downsizing, or seeking out assistance with monthly costs such as utilities.
A better answer is to prepare for retirement by outlining contingencies, working with an advisor, and coming up with a realistic budget. The earlier this is done, the more time there will be to address concerns that could give you a headache in the future.