A Reverse mortgage is heavily advertised as a great way to provide retirement income for cash strapped homeowners. Usually you’ll see reverse mortgages advertised using an aging TV or movie star encouraging seniors to unlock the equity in their home to provide extra income during retirement.
But is a reverse mortgage really as good as advertised? Or is it a ripoff that separates you from the hard earned equity you’ve built up over decades of home ownership?
In this post I’ll show you what a reverse mortgage is and how it works. I’ll also show you the good and bad aspects of reverse mortgages, and whether I think a reverse mortgage is a wise investment or a stupid decision.
I know a reverse mortgage is probably not the most thrilling thing you will read about today. But I guarantee that understanding this topic will save you a ton of money and stress at some point in your life.
So read on and learn…
What is a Reverse Mortgage?
A reverse mortgage is simply a home equity loan. They were introduced in 1989 to allow seniors 62 and older to access home equity without selling their house. The bank pays the home owner based on a percentage of their home equity until one of three things happens:
- Death of the borrower
- The borrower moves out
- The borrower sells the home
With this type of mortgage, you can take a lump sum payment, monthly fixed payments, a line of credit against your home equity, or a combination of these. Once you die, move out, or sell the home, the loan has to be paid back. This usually means the house has to be sold and proceeds used to pay off the loan.
Who Can Qualify For a Reverse Mortgage?
To qualify for a reverse mortgage, you have to meet a few basic requirements:
- All borrowers on the title must be at least 62 years of age
- Must own your home completely or only have a small balance on your mortgage
- The reverse mortgage can only be taken out on your primary residence, and you must remain in the home
- The reverse mortgage must be the primary lien on the home
- The proceeds must be used to pay off the existing mortgage if there is one.
What Are The Advantages of a Reverse Mortgage?
There are a few positive things that come with having a reverse mortgage, for instance:
- No restrictions on how to use the money. You could use it for living expenses, health care, or you could blow it all in Vegas, no questions asked.
- You get to stay in your home.
- When you die or leave the home you will owe 95% of the home’s value or the balance of the loan, whichever is smaller. You will never owe more than your home is worth.
- You retain ownership of the home
- The income you receive from the loan is tax free.
- Reverse mortgages are federally insured. If your lender defaults, you will still receive your payments.
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What Are the Disadvantages of a Reverse Mortgage?
Even though there are a few advantages to a reverse mortgage, there are plenty of disadvantages that you have to be aware of. These disadvantages can be a real problem if you are not prepared for them or don’t understand the intricacies of a reverse mortgage. Some of the disadvantages are:
Reverse Mortgages Are Complicated
You are accumulating debt over time and paying it off at the end, instead of taking out a loan and paying it off as time goes on. This can be hard to wrap your head around. Never sign up for a financial product you don’t completely understand.
A Reverse Mortgage is Debt
Getting a reverse mortgage to pay off debt is just trading one kind of debt for another, so beware!
There are a ton of upfront fees with a reverse mortgage, much like the fees associated with refinancing your home. These fees are generally higher than if you were buying or refinancing.
High Interest Rates
The interest rates associated with reverse mortgages are usually higher than the current rates for a normal mortgage.
Could Impact Benefits
If you receive benefits from the government or other entity based on income, you could lose these benefits as your income rises from the proceeds of the reverse mortgage.
You’re Accumulating Interest
As you receive payments, the amount you will have to pay back grows every month. Add interest to that and the balance grows even more.
You Can’t Access All Your Equity
You can’t get all the equity out of your home with a reverse mortgage. The rules only allow you to access a portion of your home’s equity using a calculation based on interest rates, appraised value, your age, and whether you owe any money on your home.
Since a reverse mortgage has to be paid off, you are reducing the amount of money that you will leave to your heirs. You should seriously consider whether or not you want to reduce their inheritance before you take out a reverse mortgage.
You Will Still Have Housing Expenses
Property taxes, condo fees, repairs, etc. will still have to be paid as long as you own the house. If you go into default on these, you may be required to pay back the loan early, triggering a serious financial crisis for yourself.
Reverse Mortgage- Not What It’s Cracked Up To Be
The ads you see on TV for reverse mortgages almost make it sound like it’s too good to be true. Who wouldn’t want to receive a nice check every month for the rest of their life? But what sounds like a sweet deal is actually a complicated financial instrument with serious downsides.
Remember, a bank’s job is to make money, and they make plenty of money on reverse mortgages. Although there is nothing wrong with that, just remember that money has to come from somewhere. Those higher fees and interest rates come right out of the hard earned equity you’ve built over the years.
Although a reverse mortgage sounds like a great idea, there are few circumstances where it would be to your advantage.
Question: Have you ever taken out a reverse mortgage? Have you ever considered it? Leave comment and tell me about your experience.