UPDATE: Reverse mortgages will now be more difficult to obtain. Experts say a new change in stricter lending rules will affect potentially thousands of homeowners. Reverse mortgage borrowers failed to pay for things like property taxes and hazard insurance premiums, which caused them to default on their loans. The change is expected to take place April 27, 2015.
They say, home is where your heart is, well for millions of older Americans it’s also where their money is.
According to the National Lenders Association (NRMLA), collective home equity for seniors 62 and older is $3.73 trillion, up 22 percent since spring 2012. And this year, as they have for the last four years, about 60,000 Americans will tap that equity in the form of a reverse mortgage to help fund their retirement, pay medical bills and maintain their current standard of living.
The question is, should you be one of them?
A reverse mortgage explained
You’ve probably heard a reverse mortgage explained a dozen different ways, but essentially the lender pays you to stay in your house instead of the more traditional mortgage where you pay the lender each month to live in your home. You can receive the money in different ways, too, either in a lump sum, equal payments over a fixed period of months or years (or until your death), as a line of credit to be tapped whenever you want, or as a combination of these options. You have to be 62 or older to qualify.
It’s a loan that seems almost too good to be true. That’s why it’s usually pitched on that fantasy-making machine, otherwise known as TV. The salespeople pitching reverse mortgages are usually aging TV stars like Henry Winkler, aka, the Fonze from “Happy Days,” Fred Thompson, and Robert Wagner.
Reverse mortgage lenders, by tapping into your reservoir of nostalgia and goodwill, are also hoping to get you to tap into some of that good old home equity you’ve built up over the years. They know seniors, now past their prime earning years, are especially vulnerable to suggestions promising quick fixes to their financial problems.
I’m here to tell you why you shouldn’t take out a reverse mortgage — here are 10 reasons why:
1. High fees
Closing costs for a typical 30-year mortgage might run $3,000. For a reverse mortgage, they could run as much as $15,000. That’s a lot of money just to access the equity in your own house. Reverse mortgages come with more regulations than a regular mortgage so that accounts for some of the additional fees. Lenders also charge more because they claim they take on unique risks, in that reverse mortgages aren’t based on your income or credit score.
2. Property taxes and homeowners insurance to pay
With a reverse mortgage, the property remains in your name. And because the property is in your name, you are responsible for paying all property taxes. The lender also requires that you continue to carry homeowners insurance.
3. Mortgage insurance to pay
One of the most popular reverse mortgages is called a Home Equity Conversion Mortgage or HECM. It’s a product ensured by the Federal Housing Administration. To obtain and maintain your FHA-insured HECM, you must pay a 1.25 percent premium each year on your loan balance.
4. Loan amounts are capped
With a HECM, the rule is you get about half of your equity, up to $625,500. So, for example, if you lived in a $2 million home that you owned free and clear, the most you would get is $625,500. In that case, that’s even less than half, because of the cap.
5. Interest continues to accrue
Interest has a way of adding up, and it will with a reverse mortgage. That’s because your lender charges you interest on your loan balance that you continue to carry forward year after year. So the size of your loan balance will continue to grow if you don’t pay down the balance.
6. Younger spouse penalty
To limit its risk, the reverse mortgage lender bases its distribution on the younger spouse. As younger people tend to live for more years than older people, the reverse mortgage lender will scale back the size of its loan payout accordingly. With a more limited payout, reverse mortgage lenders are protected in the event you live much longer than anyone expected.
7. Lack of choices
Currently, there is only one jumbo reverse mortgage lender in the country — someone who will make you a loan for more than $625,500. That company is Tulsa, Okla.-based Urban Financial of America, which makes loans up to $2.5 million. Without competition in the market, you know what that means. There’s no incentive to keep a lid on loan fees. As it is, Urban Financial will lend only an amount equal to 40 percent of your home equity.
8. Benefits affected
Government entitlements such as Social Security and Medicare are not affected by a reverse mortgage. But a needs-based program such as Medicaid could be. To remain eligible for Medicaid, the reverse mortgage homeowner would have to manage how much is withdrawn from the mortgage in one month to keep from exceeding the Medicaid limit.
9. Stringent repayment rules
Typically, when the last remaining borrower living in a reverse mortgage property dies, the FHA requires loan servicers to send a letter showing the balance of the loan due. Upon receipt, the heir or estate administrator has 30 days to declare whether the loan will be repaid or the home sold. If no decision is made, the lender can initiate foreclosure proceedings.
10. Heirs get less
As every month passes, the homeowner with a reverse mortgage sees debt increase and equity home equity decrease. That equation doesn’t benefit heirs, so if you planned on leaving your heirs a little something, it will probably be very “little.”
Reverse Mortgage Alternatives
We understand that everyone has money needs that continue deep into retirement. In fact, financial experts will tell you that you need 10 times your current salary stuffed in a retirement fund to make it through your golden years. Other experts have put the number at a flat $2 million.
Although your home may represent a significant source of equity, there are just too many pitfalls associated with a reverse mortgage. If you need money out, it would be far better and cheaper to do a cash out refinance, but if that’s a problem because you don’t earn enough income to make the monthly payments, then you should sell your home, and get all the money that a sale would bring.
Your home might be where both your heart and your money are, but at some point you need to separate the two. Don’t let reverse mortgage lenders play on your sentiments. Decide to downsize, sell and move on, so you can enjoy the rest of your life with more money, not less.