Never make a mortgage payment again! Get a large wad of cash and stay in your home as long as you want! You’ve probably heard sales pitches like these from celebrities in late-night television commercials. They’re touting reverse mortgages. But can they really be as great as these ads suggest, or should most people proceed with caution?
It’s easy to see why reverse mortgages might appeal to some older homeowners. The median net worth of Americans in their late 60s or early 70s was most recently calculated to be $266,400, according to a September 2020 report from the Federal Reserve. And about $200,000 of that was in home equity, according to CoreLogic.
A reverse mortgage could increase an older homeowner’s retirement income. That sounds like a great deal – but perhaps not so much when you look at the fine print of the reverse mortgage requirements.
What is a reverse mortgage?
A reverse mortgage is a loan on your house that lets you tap into your home’s equity. Like a cash advance, a lender gives you money – either a lump sum, a line of credit or monthly draws – and you eventually have to repay it with interest.
Repayment is triggered when you die, sell the house or move out for at least 12 months.
The most popular type of reverse mortgage is the home equity conversion mortgage, which is insured by the U.S. Department of Housing and Urban Development. There are several reverse mortgage requirements of the borrower and their property, including:
- You must be 62 years of age or older
- You must own the property outright or have paid down a considerable amount
- You must occupy the property as your principal residence
- You must not be delinquent on any federal debt
- You must have the financial resources to continue to make timely payment of ongoing property charges such as property taxes, insurance and any applicable homeowner association fees, etc.
- You must participate in a consumer information session given by a HUD-approved HECM counselor who is required to explain the loan’s costs and possible alternatives
You don’t get to determine how much income you’ll get. The reverse mortgage lender does that – and its calculation isn’t based solely on the value of your home and how much equity you have. Your age is also a factor: Generally, the older you are, the more home equity you have and the less you owe on it, the more money you can tap.
The HECM limit for 2022 is $970,800 – up from $822,375 in 2021, according to HUD.
Why we don’t generally recommend reverse mortgage solutions
Reverse mortgages are a complicated product and far from ideal for most people. In most cases, they’re a measure of last resort. Here are some specific reasons why we’re not fond of reverse mortgage solutions:
Fees. Lenders charge an average origination fee of 1.5% with a cap of $6,000. You’ll also pay closing costs, such as title insurance and recording fees, likely running several thousand dollars. Next, you’ll pay required mortgage insurance premiums. Finally, the lender may charge a monthly service fee of up to $35.
You owe more over time. As you get money through your reverse mortgage, interest is added onto the balance you owe each month, which means the amount you owe grows as the interest adds up over time.
You must keep paying the usual bills. Because you retain the title to your home in a reverse mortgage, you’re still responsible for property taxes, insurance, utilities, fuel, maintenance and other expenses. The FHA might also require you to pay for a yearly home inspection.
Downsizing may put less in the bank. Many homeowners’ needs change and downsizing in retirement is common. A reverse mortgage may significantly reduce your after-tax sale proceeds.
You can’t leverage the tax benefit. The interest on a reverse mortgage isn’t tax deductible until the loan is paid off. Since that’s unlikely to happen while you’re living, you won’t benefit from the deduction.
Going to a nursing home could mean losing your home. Reverse mortgages may be required to be paid off entirely if you leave your home for more than 12 months. But even if you move out for just a few months – say, to a nursing home or a rehabilitation center after an injury – you may be required to pay back the lender all the money you received during that time, plus interest. This may be dependent upon whether you have anyone else that is still living in the home and if they are a co-borrower on the loan. For many seniors, this could put them in the position of having to sell the home. Thus, when they leave the rehab center, they have no home to return to. And because they owe so much to the lender, they often receive none of the proceeds from the sale of the home.
Your home can be foreclosed. If you fail to pay property taxes, insurance and homeowner association dues, or if you fail to maintain the home according to FHA standards, you could lose your home to foreclosure.
Heirs will get less inheritance and a strict deadline. A reverse mortgage accelerates the depletion of equity in your home, so there will be less to give after you’re gone. Furthermore, once both homeowners have died, the reverse mortgage typically becomes due within six months. That can be a headache for your heirs – who have to quickly mobilize to prepare the home for sale – and it may also be a disappointing realization if they would have preferred to rent out the property or retain it for their own use.
Spouses can end up homeless. This could happen if one spouse moves to a nursing home or dies. Unless the remaining spouse is a co-borrower or meets other HUD requirements, at that point they must pay off the reverse mortgage in full or lose the property to the lender.
The latter scenario is one reason we believe a reverse mortgage is more appropriate for a single or widowed person than for a married couple. Another reason is that the loss of one spouse’s income could cause the other to be unable to afford staying in the house.
A reverse mortgage is also more appropriate for older people – perhaps those who are around 80 years old. That’s because they are less likely to be impacted if inflation rises during the term of the mortgage.
Ideally, you’ve started working as early as possible with a financial advisor to create an integrated financial plan that helps you safely navigate your retirement years and avoid potentially costly options like reverse mortgages.
Who might still consider a reverse mortgage?
Clearly, reverse mortgages aren’t for everyone. Although you might not consider one yourself, what about your parents, older relatives or friends? If you know anyone thinking about a reverse mortgage, reach out to an Edelman Financial Engines planner to talk through the details so we can help them make the best decision for their personal situation.