Reverse Mortgage Pros and Cons
TABLE OF CONTENTS
Defending and protecting elders is a fundamental human instinct. And that’s why this chapter was created and included in our Guide – to very openly candidly explain reverse mortgage pros and cons.
Some people get frustrated when they think of reverse mortgages. They see advertisements on TV that portray a rosy picture of seniors frolicking on a beach, the good times supposedly created from loan proceeds. They hear about a friend-of-a-friend’s parents who lost their home and it had something to do with a reverse mortgage. Maybe there’s some evil Wall Street conspiracy, some legal fine print that’s intended to trick vulnerable people?
You know that buying a home is an emotional experience. Well living in one for many years and then putting it up as loan collateral is also an emotional experience. To a borrower, the house is their home. To the lender, it’s collateral. Does this sound cold? Maybe. But the choice of words here is intentional. Let there be no confusion, reverse mortgages are financial transactions; they are loans that carry interest. It is unwise to think otherwise.
By a very wide margin, people who work in the mortgage industry have good intentions. Banks aren’t interested in foreclosing and running a secondary business as real estate holding company. Seasoned loan officers genuinely want to help. They know how to evaluate a borrower’s circumstances and determine whether a reverse mortgage is an appropriate financial vehicle. Whether it’s explaining reverse mortgages or finding an alternative, we feel good helping people. What’s more, mandated HUD-approved counseling for reverse mortgage borrowers adds an additional level of consumer education. Absorb as much as you can.
So let’s review some reverse mortgage pros and cons.
REVERSE MORTGAGE ADVANTAGES
Remain in Your Home
A lot of people feel more comfortable in the home where they’ve been living for many years. Homes also provide a sense of independence. No doubt, just the notion of ‘home’ triggers a lot of emotions. It’s just human nature to want to hang on to it.
No Monthly Payments
With a reverse mortgage, there are no payments during the length of the loan. Costs such as accrued interest, mortgage insurance premiums, interest charges and lender service fees are all due when the loan is paid off.
FHA guarantees that if the lender fails to make payments to the borrower as agreed, the FHA will make those payments on behalf of the lender.
Mandatory reverse mortgage counseling gives borrowers a chance to ask a lot of questions from a neutral third party. HUD-approved counselors are not loan officers. They only have on mission: to help borrowers understand how reverse mortgages work.
Reverse mortgages are non-recourse loans. Meaning, borrowers never wind up owing more than the home is worth. Subsequently, no debt is passed to heirs.
Right of Rescission
Borrowers have three business days after closing to cancel. There’s a way to back out if folks have any misgivings about their loan.
No Prepayment Penalty
Borrowers can pay the loan back at any time without a penalty for doing so.
In most cases, cash disbursements from a reverse mortgage are not taxed.
REVERSE MORTGAGE DISADVANTAGES
Other Occupants May Be Affected
The loan comes due when the borrower is no longer HECM-eligible. Eligibility goes away when the borrower sells the home, moves out or dies. Other occupants, such as dependents, will need to vacate the home at that point. It’s a good idea to plan ahead for dependents or others living in the home for the day when the loan comes due.
There is a provision to protect non-borrowing spouses. Anyone else who lives on the property, who is not on the deed nor a spouse will not have the same rights.
When the borrower moves out or passes away, the loan is due. The principal, interest and other finance charges are repaid to the lender. Any remaining funds would belong to the heirs. Heirs will not be liable for loan amounts that exceed the home’s value (an advantage). In most cases, the home is sold. However, if heirs want to keep the property, they’ll need to pay the loan off (a disadvantage).
Mortgage Insurance Premiums
Mortgage insurance protects the lender; they’ll get paid back from the FHA insurance pool if you default. Question: Who pays for the insurance? Answer: You. Mortgage insurance premiums — whether it’s a forward or reverse mortgage — add extra cost.
Initial Mortgage Insurance Premium (IMIP) is a one-time fee due at closing. The IMIP fee is either 0.50% or 2.5%, depending upon the percentage of home equity you withdraw. Upfront costs become muted the longer one stays in their home.
Mortgage Insurance Premium (MIP) – an annual fee for the life of the loan, 1.5% of the outstanding loan amount.
Ongoing Property Expenses
Borrowers are still have a responsibility to be a good steward of the property. Borrowers can be forced to repay the loan (the loan gets called) if they:
- Fail to pay state and local property taxes
- Fail to pay hazard and flood insurance
- Fail to maintain and keep the home in good repair – after all, the property is the collateral
Property expenses are not inherently just a reverse mortgage disadvantage. After all, every homeowner is responsible for local taxes, etc. However, it’s worth mentioning ongoing property expenses in the context of reverse mortgages. Why? Because failure to keep up with expenses could lead to foreclosure. And foreclosing a senior’s home carries a whole lot more weight and consequence than foreclosing on a younger borrower.
Alternatives to Reverse Mortgages
If after reading the reverse mortgage pros and cons above, you find them unpalatable, you do have some alternatives. In some cases, a Home Equity Line (HEL) or a Home Equity Line of Credit (HELOC) may be better. The home is the collateral for both HELs and HELOCs.
A HELOC is an open line of revolving credit that borrowers can dip into from time to time – if and when they need it. This might be a good option if the borrower is only looking for access to cash in case of an unpredictable emergency. HELOCs are generally adjustable rate loans, so if the borrower pulls money out, payments could vary from month to month.
A HEL is a loan for of a fixed amount of cash, pulled from home equity in a lump sum. The terms will include a fixed number of payments for a certain period of time. Most likely it will be a fixed interest rate. Say you are a senior with a good, regular retirement income but need $20,000 to repair your roof. It’s a one-off expense you’d rather pay for over time. This would be a good time to use a HEL instead of a reverse mortgage.
Other options for consideration:
- Refinance the existing mortgage to a lower rate to lower monthly costs
- Downsize, sell the home and buy a smaller house
- Apply for senior assistance programs from federal, state and local authorities