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.

reverse mortgage explained image

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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.

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  • JB

    I agree with Cliffy. These reasons are not valid, especially #9. The estate has 1 year, not 30 days. Even further, in the off chance the mortgage balance is higher than the value, the estate can buy the house for 95% of the current value. This is a great example of an article where only half the story is told.

    If anybody is curious how to get the other half of the story, call your local mortgage company who offers HECMs. Don’t worry about getting pressured into anything, because FHA requires a 3rd party consultation to ensure you understand how it works and you aren’t doing it for the wrong reason(s).

    This is a great tool for many people and I encourage anybody remotely interested to do their research.

  • Eric Stonestreet

    1. High fees- There are numerous options available that would allow a person to borrow funds with closing costs at or below typical costs for a HELOC or other mortgage.

    2. Property taxes and homeowners insurance to pay- this is an absurd point…you still pay taxes and insurance whether you have a reverse mortgage or not.

    3. Mortgage insurance to pay- Yes, MIP is 1.25% per year, and this is because a HECM is a non-recourse loan that protects you and your heirs from any liability beyond the home’s sale price in the event you wind up owing more than the home is worth by living well beyond life expectancy or due to market collapse like in 2008.

    4. Loan amounts are capped- your figures are incorrect which shows how very little research you actually did on this article. HECM’s provide borrowers with between 50-75% of home value, depending on their age. The maximum proceeds on a reverse mortgage are not $625,500. That is the maximum value considered on the loan. So, if someone with a $2,000,000 home at age 62 wanted to borrow money against their home, they would be eligible for approximately 50.5% of the $625,500. This lower number would also be used to compute closing costs, reducing the potential fees. This leaves the borrower with the remained of funds as equity. Though the reverse does not provide the maximum available funds as some mortgages might, it is a great fit for some people that need access to a smaller percentage of their available funds, or that cannot qualify for a traditional mortgage due to credit or income.

    5. Interest continues to accrue- interest accrues on all mortgages, you simply make payments each month on “forward” loans that prevent the interest from accumulating beyond that month. HECM borrowers are able to make payments at any time without penalty, and many of them do make payments each month, however, they have the ability to not make payments without fear of losing their home.

    6. Younger spouse penalty- reverse mortgages are based on life expectancy, so yes, younger borrowers are able to borrow less money. However, if they take a reverse mortgage line of credit, the available funds increase each year by a percentage that is equal to the interest rate charged on borrowed funds plus the 1.25% MIP fee, so borrowers will see their available funds increase dramatically should they choose to take a line of credit for emergencies and they are able to avoid accessing their funds up front.

    7. Lack of choices- the jumbo market for reverse mortgages has always been non-existent for a simple reason, there is simply no demand for them that isn’t met easily by the federally-insured HECM reverse mortgage. In reality, the current jumbo loan is actually quite inexpensive compared to most other loan options available, though it only works for borrowers with very expensive homes and good credit.

    8. Benefits affected- as you said Social Security and Medicare ARE NOT AFFECTED. Medicaid and other needs-based programs could be affected, so it’s always advisable to consult with a benefits expert prior to taking out any mortgage, including traditional home equity loans or cash-out refinances.

    9. Stringent repayment rules- your statements here are misleading and incorrect. Upon the death of the last remaining borrower living in the property, the loan servicing company sends a letter to the estate asking them how they intend to repay the loan. Typically heirs will either be selling the home and repaying the loan, and then the heirs will keep the remaining equity, or they will want to keep the house. If they do decide to keep the home they will either use other assets to repay the loan, or they can potentially refinance in to their own loan. If the heirs are communicating with the servicing company then they will allow them time needed to complete one of these options. Should the borrower owe more than the home is worth, the heirs have the right to just walk away with no further liability to the estate, or should they decide to keep the home, they can repay just 95% of the current appraised value and be allowed to “purchase” the home for that reduced amount. Nobody is being forced out of their home, and when someone dies with a forward mortgage in place, the lender also requires that their loan be repaid or they will foreclose, they just have the option to continue accepting monthly payments by allowing an heir to assume the loan.

    10. Heirs get less- that’s true, they get less, but this is true of any mortgage, credit card debt, car loan, or other liability…it reduces the value of your estate. The home equity is the largest asset that most older American’s have. They need this money to live on, and if it’s not available they’ll either go without or be reliant on their kids for support. Rather than asking your kids to support you through retirement just so you can leave them a home they won’t likely want to keep, why not access your funds with a reverse mortgage, support yourself, and leave less in the end but without taking as much from your kids to begin with?

    You suggest people downsize. What if downsizing doesn’t allow the person to find a home they are comfortable in, or happy in for less? What if rent is more than their expenses in their home? There are dozens of reasons that downsizing doesn’t work, and you make light of them with your arrogant advice and completely uninformed article. You should be ashamed of the lack of knowledge you display when you write an article like this. You have damaged countless seniors in our country that will now not consider a reverse mortgage that may have allowed them the funds they need to live a happy retirement.

  • swr

    best advice from the whole article is the last paragraph..”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.”…lenders who pander to seniors are in it for only one thing..making money for themselves…not the welfare of the senior…!