Proponents of reverse mortgages tell us that this loan will let qualified senior homeowners convert illiquid home equity into available tax-free cash. They go on to tell us that when used appropriately, a reverse mortgage could be the solution to living an independent, fulfilling life. You are still obligated to maintain the property and to pay real estate taxes and homeowner's insurance and you can stay in your home for the rest of your life. The unique aspect of a reverse mortgage is that you don't have to make a monthly mortgage payment. That's what's thought of as the "magic" of a reverse mortgage. You can elect to receive a lump sum of cash, a monthly check for life, or a line of credit to be used if needed—all with no monthly payment for as long as you live in the home.
Now, if all of this information sounds like the proverbial ‘free lunch’ to you – you might be right. Anyone contemplating one of these mortgages needs to be aware of all of the facts before deciding that a reverse mortgage is the right plan for them. Here are just some of the disadvantages of this type of loan:
- These loans typically have very high up-front loan fees, including higher than normal loan origination fees. Since you may be encouraged to add these fees to your loan, the interest on these financed fees can add up quickly further reducing your owner’s equity.
- The interest rates on these loan could be as much as 5% higher than rates charged on a standard 30 year mortgage. Keep in mind that accrued interest is added to principal monthly since you are making no mortgage payments.
- Some lenders charge substantially higher closing costs and higher mortgage insurance payments than a standard mortgage. If you get your mortgage guaranteed by Federal Housing Administration (HECM lenders) there will be an additional fee in the form of insurance. This insurance is added protection for you or your heirs should the value of your home fall below the loan amount, but an added annual fee of 1.25% of the loan balance still adds to substantial costs to this loan.
- The general rule is that a reverse mortgage will pay about half of the equity in your home. With the possibility of the interest and other fees draining the remaining equity in the house that likely means that you will leave little or nothing to bequeath to your children.
- There is the ‘Rule of 95’ that allows your children to buy the house at 95% of the appraised value as of your date of death (other restrictions apply). Take care, although this is mandatory for all HECM lenders, not all reverse mortgage lenders offer this option.
In the final analysis, it’s likely that your children would rather have you live well in your declining years instead of sacrificing any quality of life to provide an inheritance. If a reverse mortgage is the only means of providing that other than having to borrow from children, most of my clients would opt for the reverse mortgage. Here’s an idea: What if you were to replicate the terms of a reverse mortgage with your children supplying the needed funds?
Call us to schedule a complimentary consultation or register online for one of our seminars on this or other topics of interest to you and your loved one.
Reference: Fifty-Plus Advocate (April 26, 2016) "Top ways to use a reverse mortgage" and US News.com (December 11, 2012) “5-reasons-to-avoid-a-reverse-mortgage”