The Pitfalls of Reverse Mortgages
Is a Rising Debt Home Loan the Best Retirement Strategy?
Oct 22, 2009
The reverse mortgage allows homeowners who are at least 62 years of age to convert the equity in their residence into cash without having to sell the home or take on additional monthly bills. A reverse mortgage may seem like a great idea in theory. An older person who has built up equity in his or her home can get paid just for living in the home for the rest of his or her life. But any consumer who is considering such a mortgage should be aware of the down side.
How Does a Reverse Mortgage Work?
With a traditional mortgage, the homeowner borrows money to purchase the house, then makes monthly payments to pay off the loan. With a reverse mortgage, the homeowner receives money from the mortgage lender and does not have to pay it back for as long as he or she lives in the home. The reverse mortgage loan is repaid when the homeowner dies, sells the home or otherwise stops living in the home for at least 12 months.
A Reverse Mortgage Does Not Mean Easy Money
Although it may seem to many seniors that getting paid to continue to live in their home is a good retirement strategy, a reverse mortgage does not necessarily amount to easy money because:
- There are significant fees and costs involved.
- The total debt on the loan increases over time.
- The homeowner remains responsible for property taxes, homeowner's insurance and home maintenance.
- A reverse mortgage uses up the home equity.
Reverse Mortgages Cost Money
There are fees and costs associated with obtaining a reverse mortgage similar to those involved with a traditional mortgage. The difference is that the fees and costs for a reverse mortgage tend to be higher than those associated with a traditional mortgage. According to the FINRA Investor Education Foundation, the fees and costs may be as high as 4-8% of the total loan amount, and they are either paid out of pocket or deducted from the loan amount.
Furthermore, a reverse mortgage must be the primary mortgage on the home. If the home is burdened by other mortgages, the homeowner must borrow enough to pay off the other mortgages. This reduces the amount of money available to the homeowner.
A Reverse Mortgage is a Rising Debt Loan
The total debt that is owed on the reverse mortgage increases over time because the interest charged on the balance is added to the amount each month as funds are advanced to the homeowner. Additionally, most reverse mortgages have variable rates that are tied to a financial index, which means that the interest rate rises as the index rises. Moreover, interest on a reverse mortgage is not tax deductible until the loan is paid off in whole or in part.
The Homeowner Remains Responsible for Certain Costs
Because the homeowner retains title to the home, the reverse mortgage has no effect on the homeowner's responsibility for property taxes, homeowner's insurance and home maintenance. In fact, if the homeowner fails to meet any of these obligations, the reverse mortgage lender may have the right to foreclose on the home.
Reverse Mortgage Uses up the Home Equity
By its very design, a reverse mortgage decreases the equity in the home. Accordingly, it may not be the right choice for a homeowner who anticipates needing the home equity at a future date or who would prefer to leave this asset to his or her heirs.
Housing Counselors
One's home is often one's most significant asset. Before deciding to burden the home with a reverse mortgage, a homeowner of retirement age should consider all the risks involved and should seek the advice of a counselor from an independent government-approved housing counseling agency. A counselor may be found through the U.S. Department of Housing and Urban Development.
Additional Resource: How to Find a Single-Purpose Reverse Mortgage
Disclaimer: This article is in no way intended as legal or financial advice. For questions related to specific legal or financial issues, one should contact an attorney or financial expert in one's local area.
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