For seniors struggling with expenses, a reverse mortgage may seem like a convenient option. Although such a lifeline looks attractive, a closer look can tell otherwise. The industry is full of scams; fees are high and often hidden. Additionally, reverse mortgages can have variable interest rates, so you may end up owing more over time.
Taking out a reverse mortgage is a big financial decision, and it’s essential to understand the pros and cons.
What is a Reverse Mortgage?
A reverse mortgage is a loan option that allows homeowners to tap into the equity in their home to free up money for living expenses, medical bills, or other needs.
Three types of reverse mortgages are available: single purpose, federally insured, and exclusive. 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’s what this article is about.
For homeowners over 62, who have paid off all or most of their home (usually at least 50%), a reverse mortgage can free up money for expenses. Typically, a reverse mortgage does not mature until the owner moves out, dies, or chooses to pay off the loan in full. This loan option is only available for primary residences.
When a Reverse Mortgage Might Make Sense
A limited number of homeowners meet the criteria for a reverse mortgage. For those who do, this can be an interesting option, for several reasons:
Stay at home: This can prevent them from having to downsize. A lump sum reverse mortgage payment can be used to pay off an existing mortgage, potentially freeing up cash for cash-strapped homeowners. Monthly payments can help pay for living expenses.
Payment Options: The flexibility of how a homeowner can choose to receive funds from a reverse mortgage can be appealing. Funds can be disbursed as a lump sum payment, line of credit, fixed monthly installments or a combination of these options.
Unlike distributions from a retirement account such as a 401(k), the IRS does not treat reverse mortgage funds as income; they are therefore not taxable.
No credit/unstable credit: Many reverse mortgages do not require a credit check as part of the application process. For homeowners with weak credit, this can make reverse mortgages a feasible alternative to other loan options.
House price fluctuation: If the value of the home falls below the reverse mortgage balance, the borrower’s heirs cannot owe more than the value of the home.
On the other hand, if the value of the house appreciates, there may remain proceeds from the sale of the house after the payment of the mortgage and related costs. In this case, the owner or his heirs will come out on top.
Why almost always Doesn’t Make sense
Although reverse mortgages have some positive attributes, the bad ones tend to outweigh the good ones for most people.
Interest on a reverse mortgage accrues monthly and is added to the balance. In other words, each month the homeowner has to pay interest and fees on the interest and fees that were added to the previous month’s loan balance.
Lenders can require borrowers to meet strict home maintenance standards to protect the home’s resale value. Failure to meet loan conditions, such as not maintaining the home properly or neglecting property taxes, can force the borrower to prepay the mortgage.
Reverse mortgages include other strict guidelines for homeowners and their heirs. If a borrower leaves the residence or ceases to live in the house for more than a year, before the loan is repaid in full, the loan will have to be repaid.
In the event of the owner’s death, the heirs must repay the entire loan, but this amount may not exceed the value of the house. Exceptions may apply if the owner is married or if there are non-spouse co-borrowers on the loan.
Marriage complicates reverse mortgages. If your spouse has a reverse mortgage and they die or move out, 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 years old and were co-borrowers, the spouse who lives in the house will continue to receive the funds from the reverse mortgage, if applicable.
If the remaining spouse is not a co-borrower, but is a qualifying spouse (married to the borrower at the time the borrower applied for and closes the loan), the reverse mortgage will be deferred. This means that the qualifying spouse can continue to live in the home and will be responsible for the terms of the reverse mortgage. However, the qualifying spouse will not receive reverse mortgage funds.
Leaving a surviving spouse without a major source of income is not ideal. For this reason, unless you and your spouse are 62 and co-borrowers on the reverse mortgage, this might not be a good option for you.
The reverse mortgage industry is rife with fraud. In fact, reverse mortgage scams are one of the top scams AARP warns its members about. Predatory moneylenders prey on cash-strapped seniors.
Expensive fees and mortgage insurance
Reverse mortgages are often littered with costly fees. Set-up fees, service charges and mortgage insurance premiums can snowball into exorbitant costs.
Mortgage default insurance pays the difference if a home’s equity falls below the reverse mortgage amount. The initial mortgage insurance premium is paid at closing and is generally 2% of the appraised value of the home. Ongoing mortgage insurance premiums are levied annually and are generally 0.5% of the outstanding loan balance.
Expensive interest payments
The majority of reverse mortgages have a variable interest rate. This means that the interest rate may increase over time, making the cost of the loan worse.
Another striking difference between reverse mortgages and regular mortgages is that interest payments on reverse mortgages are not tax deductible until you repay the loan in full.
Although a reverse mortgage borrows against a home’s equity, it can also reduce it. If you’re counting on your home to play an important role in your family’s legacy, you might want to think twice.
Avoid the dilemma altogether
A problem can be solved by 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.
It is best to make changes before the situation becomes hopeless. Alternatives include home equity loans, refinancing, downsizing, or finding help with monthly costs such as utilities.
A better answer is to prepare for retirement by outlining the contingencies, working with an advisor, and establishing a realistic budget. The sooner this is done, the more time there will be to address concerns that may give you headaches in the future.
The Epoch Times Copyright © 2022 The views and opinions expressed are solely those of the authors. They are intended for general informational purposes only and should not be construed or construed as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or other personal finance advice. Epoch Times assumes no responsibility for the accuracy or timeliness of the information provided.