Reverse Mortgages: A Bad Deal For You (Most of the Time)

when-does-a-reverse-mortgage-make-sense_363You have probably seen the commercials on TV for reverse mortgages.  They tend to feature older actors, like Fred Thompson of Law and Order, who speak in deep, reassuring voices in an attempt to convince you that reverse mortgages are the greatest thing since sliced bread.  But, except for a few very rare circumstances, they’re usually a bad deal for the elderly homeowner.

A reverse mortgage is a loan made available to homeowners who are at least 62 years or older that enables them to convert part of the equity in their home into cash.  For many Americans, the equity in their home is their largest financial holding, and for too many, it is their ONLY financial holding.  Years of government incentives to buy expensive homes have resulted in millions of elderly Americans being “real estate rich” but “cash poor.”

Reverse mortgages were designed to help retirees with limited income use the accumulated wealth in their homes to cover basic monthly living expenses such as food, utilities, and health care. However, there is no restriction for how reverse mortgage proceeds can be used, and many elderly people are enticed every year to use reverse mortgages for travel and other lifestyle expenses.

The loan is called a reverse mortgage because the traditional mortgage payback stream is reversed.  Instead of making monthly payments to a lender, as with a traditional mortgage, the lender makes payments to the borrower.

You are not required to pay back the loan until the home is sold or otherwise vacated.  As long as you live in the home, you are not required to make any monthly payments towards the loan balance, but you must remain current on your property taxes, homeowners insurance and condominium fees (if you live in a condo). Additionally, you must continue living in the home until you die or the reverse mortgage loan has been repaid.

There are three kinds of reverse mortgages:  single-purpose, federally-insured, and proprietary.  Single-purpose reverse mortgages are offered by states, municipalities, and some non-profit organizations.  Federally-insured reverse mortgages are usually issued by private companies, but are backed by the federal government via the Department of Housing and Urban Development to protect the companies from the risky nature of reverse mortgages.  And finally, proprietary reverse mortgages are backed by the same companies that issued them (they are not backed by the government).

Different lenders may have varying policies about other liens on the home, age requirements, financial counseling, etc.  But no matter what route you take to get a reverse mortgage, they generally work the same way.  The most common form is the federally-insured reverse mortgage, or Home Equity Conversion Mortgage (HECM).

HECMs offer different ways to extract money from your home, such as fixed cash payments each month for a specific time, fixed payments for the duration you live in the home, a line of credit, or combinations of those options.  The payments are non-taxable, and no repayment is required until you either die or sell the home.  If an owner enters hospice care or a retirement home on a permanent basis but still owns the home, then lenders generally require repayment within 12 months.  Another key feature is that the amount you repay legally cannot exceed the appraised value of the home upon sale or death.

Sounds like a good deal, right?  You get money, still get to live in the home, you don’t have to repay it unless you move or die, and you will never owe more than can be paid back from the sale.  So how could this go wrong?

Reverse mortgages are being pitched as reasonable options for average people, and based on the facts I presented above, you may be ready to jump on the bandwagon.  But it’s not that simple.  Generally speaking, if you’re considering a reverse mortgage, you are usually looking for extra income.  Translation:  you probably don’t have enough money to afford the lifestyle you’re currently living and you are borrowing against the future to pay for today.

One of the worst decisions you can make in retirement is to go into debt, but that is exactly what a reverse mortgage is.  Folks interested in reverse mortgages are usually having trouble making ends meet, and the slick advertisements touting government guarantees make reverse mortgages look very attractive; however, debt is just another word for slavery. Over the years, I have witnessed retired people who took out reverse mortgages to enjoy the good life eventually succumb to old age and have to move to a nursing home. Because they could no longer live in their homes, they were forced under the provisions of their reverse mortgages to sell exactly at the time when housing prices collapsed in 2008, resulting in their home values barely covering the loans on their reverse mortgages. The banks ended up getting all of the equity rather than their children or charities like they had hoped.

debt-management-1Compared to other loans, the origination fees and interest rates on reverse mortgages can often be exorbitant.  Since you will not make payments, there is usually no credit check.  So to offset some of the risk, lenders charge thousands of dollars in fees (sometimes much more) up front.  Moreover, the interest rates, often based on age, are typically much higher than a traditional mortgage or home equity line of credit.  In other words, the lender ends up getting a big chunk of the money you are paying them for the privilege of going into debt.

If you intend to leave your children anything when you die, they’ll either be required to repay the loan or sell the home you wanted to leave them.  In addition, if you ever intend to move, you will have to repay the loan immediately, whether or not you can afford to.  In short, you really limit your options in retirement by going into debt via a reverse mortgage.

If all that wasn’t enough, you’re still responsible for all of the costs associated with home ownership.  That means property taxes, homeowners’ association fees, repair and maintenance costs, insurance, etc.  If you fail to meet those requirements, the lender is legally able to foreclose on you.  If you find yourself in a home where your expenses go up frequently (like a nice neighborhood where home values—and thus property taxes—are rising), you could easily find yourself in a home you can’t afford now with large sums of debt associated with it.

Really, the only reason you should consider a reverse mortgage is if you have exhausted all your other options.  If you can’t afford your current lifestyle, downsize by selling your existing home and buying (or renting) a more affordable option, sell things you don’t need, and consider getting a part-time job.  You should not be borrowing from tomorrow to afford today, no matter how easy or credible the baritone voices on TV tell you it is.

A reverse mortgage is one of the most expensive forms of debt you can get.  If anything unexpected happens, like the need for long-term care, you could find yourself completely broke very quickly.  Unless you have exhausted all your financial options, intend to never move (even into a nursing home), and are determined when you die to leave little or nothing to your kids or favorite charities, I recommend avoiding a reverse mortgage.

If you have additional questions about reverse mortgages or any other financial concerns, please contact me at joe@coco-ent.com.

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