Reverse Mortgage Disadvantages
It is critical to understand any reverse mortgage disadvantages if you are considering this program for yourself or a loved one. A reverse mortgage (sometimes called a Home Equity Conversion Mortgage or HECM) is a financial tool, and like any other financial tool, it’s not for everyone. We developed this website to educated people fully on all aspects of a reverse mortgage, including the disadvantages, because it’s the right thing to do. We are professionals in the field, but we don’t want to make a sale to someone who is not seeing the complete picture.
Probably the main disadvantage people tend to think of is the cost. A reverse mortgage costs more than regular loans primarily because of the two kinds of mortgage insurance (MI) that are required. The up-front MI is 2% of the value of the home, up to a maximum value of $625,500. This means that if your home is worth $500,000, you are paying $10,000 just for the up-front MI. This doesn’t come directly out of your pocket, of course, it can usually be rolled right into the loan. The other kind of MI is annual, and is 1.25% of the loan balance. Again, this is not something you pay for directly, but it affects the rate at which your loan balance increases over time.
This cost can be offset in a couple of ways, and the first is by the passage of time. If you are considering selling your home or moving in the next few years, a reverse mortgage is probably not for you. The longer you have this product, the more the costs are stretched out over time and are thereby effectively reduced. This loan was designed to enable people to stay in their home and have a more satisfying lifestyle with no monthly payments.
Another way the cost can be offset is by choosing a HECM Saver. This option is a relatively new product developed by the FHA to fill the gap of a lower-cost HECM for those who don’t need the full proceeds of other HECM products. The HECM Saver practically eliminates the up-front MI for a trade-off of not qualifying for as much money.
The other main disadvantage of a reverse mortgage is connect to its main feature – no monthly payments. If you are not making payments, how is the loan to be paid off? What about the interest? The answer is that the loan is not paid off until the end of the term, which is after the borrower passes away or decides to sell or move away. Until that point, the balance increases with the accrual of both interest and the annual insurance mentioned above. Instead of you building equity, as you have done all your life, you are now decreasing your equity.
If your heirs are counting on receiving every penny of your current equity, then a reverse mortgage is probably not for you. However, most adult children are fine with equity decreasing if it means that their parents are going to be happier and at the same time not as likely to look to the children for financial help. Plus, the reverse mortgage needs to be put in perspective. Almost all seniors face a transition where they stop putting money into investments and retirement accounts and start pulling money from them. A home is an investment and the reverse mortgage allows you to pull money from it like any other investment. If you are age 70 and have a good-sized mortgage with 20 years left on it, you are not likely interested in paying it down to zero. At this point in life you are more interested in your cash flow and maintaining a decent standard of living.
Most reverse mortgages end with still a significant amount of equity remaining, and typically the home is sold and the borrower or the estate pockets what remains after paying off the mortgage and other selling costs, just as with any other mortgage. If it should happen that the value of the home is less than what is owed, the MI assures that the lender will get all that’s owed them, and the borrower or estate will not be liable for anything more than the value of the home.
If you are receiving Medicaid or SSI (as opposed to standard Social Security), and you receive a lump sum from a reverse mortgage, it could affect your Medicaid or SSI eligibility. Those programs look at how much money you have in the bank, and if you suddenly have much more, it could be a problem. In this case you’d want to structure the reverse mortgage to pay off your loan without putting additional money in your bank account. You can do this with a line of credit option in many cases.
Another disadvantage of a reverse mortgage is the requirement that you live in the home at least 51% of the year. This means you have to be careful if you like to spend considerable time at a vacation property. Also, if you are gone for any reason from your home for more than a year at a time, the mortgage could be called due and payable. However, the reality is that if your health deteriorates to the point where you are in a recovery facility for more than a year, you are not likely to be returning to an independent living situation anyway. Plus, if a husband and wife are both on the loan, as long as one of them is still at the home, there is no problem.
A final disadvantage of the reverse mortgage is the requirement that every borrower be at least 62 years old. This can be a problem if the spouse is younger. In this case the spouse cannot be on the loan, and if the person on the loan should pass away, the loan becomes due and payable. If the surviving younger spouse is still too young for a reverse mortgage, and doesn’t qualify for a regular mortgage, they would probably need to sell and move. Sometimes the older spouse can take out life insurance to make sure that if they were to pass away, the proceeds would be enough to pay off the loan and keep the surviving spouse in the home. Actually, in many situations the surviving spouse would not want to remain in the home anyway. In any case, you need to think very carefully about doing a reverse mortgage if only one of you qualifies by age.
Please consider all your options carefully and do your homework at this site and others, as well as discussing with trusted advisors. Whether you end up with a reverse mortgage or not, the most important thing is that you make a decision you feel comfortable with and is right for you.