A reverse mortgage is essentially a loan against your home that you do not have to pay back for as long as you live there. It allows homeowners age 62 or older to borrow cash from the equity in their homes without having to make monthly payments. A reverse mortgage is often advertised as a great source of easy money for older homeowners to supplement their income, pay healthcare expenses or use the money as they please. But while there are potential benefits to a reverse mortgage, it may not be the best option for everyone. With the number of potential borrowers growing with the aging population, it’s important that homeowners fully understand the risks involved.
Remember That a Reverse Mortgage is a Loan That Must Be Repaid
Not all advertisements clearly indicate that a reverse mortgage is a loan. In fact, a reverse mortgage is a very complicated loan that uses home equity as collateral, just like a mortgage is used to purchase a home.
Be Aware That Not All Reverse Mortgages Carry Insurance and Other Protections from the Federal Government
The most common type of reverse mortgage—the Home Equity Conversion Mortgage or HECM—is offered as part of a program from the U.S. Department of Housing and Urban Development’s Federal Housing Administration. The FHA has protections for the lender as well as the borrower. In the case of the latter, for example, if the borrower or heirs sell the home to repay the reverse mortgage (instead of keeping the house and repaying the loan otherwise), the total debt will never be greater than the value of the home.
However, there are several types of reverse mortgages that are not FHA-insured. These are mostly reverse mortgages developed and offered by private companies, nonprofit organizations, and state and local governments. They may not offer the same guarantees and protections as an FHA-insured HECM.
Understand the Costs and Fees, Which Can Be Significant
Most reverse mortgages have an origination fee, closing costs and periodic servicing fees. There also is an additional monthly insurance premium for an FHA-insured reverse mortgage. The total amount of fees will depend on the loan product. And while the costs and fees can be added to the reverse mortgage instead of being paid up front, doing so increases the loan balance and incurs interest charges.
Borrowers also should keep in mind that the more cash they take out and the longer they go without making loan payments, the interest charges and other costs can use up much or all of the equity, leaving fewer and fewer assets for the borrower or heirs. And if the borrower or heirs want to keep the house instead of selling it, the full loan amount would be due and payable from their own funds, even if it’s more than the value of the property.
Because the costs and fees can be extremely high most experts generally advise homeowners not to take out a reverse mortgage if they plan to stay in their home less than five years or if they simply need extra money for small expenses.
Do your Research and Shop Around Before Committing to a Reverse Mortgage
To understand the potential pros and cons of a reverse mortgage, talk to financial advisors and qualified housing counselors. Depending on your circumstances, there may be other, less expensive options available to you. Explore different kinds of loans (including a mortgage refinancing, a home equity loan and a home improvement loan) and programs from local government agencies or nonprofit organizations. In some cases, it may even make financial sense to sell your home and downsize to a less expensive home or even a rental.