Are reverse mortgages bad? Some accountants, attorneys, and financial advisors think so. Are they correct? If so, why are reverse mortgages a bad idea?
I once chatted with a retired woman named June (not her real name) who had a free and clear home, was living on a $1,300 Social Security check, and had no heirs. Every dollar of June’s income went to basic living expenses such as groceries, power bill, water bill, etc. June had no extra money to cover a financial emergency or do anything fun for a change.
June’s home was worth around $350,000, so a reverse mortgage would be very beneficial. Nevertheless, she was unsure about the reverse mortgage, so she decided to ask an old accountant friend for his opinion.
The response? “Nope, no way, don’t do it. Too risky!“
I asked June why her friend thought a reverse mortgage was “too risky”, but he apparently didn’t elaborate.
Like any financial product, a reverse mortgage isn’t always the perfect fit. But, are reverse mortgages bad? Is June’s accountant friend correct when he’s says a reverse mortgage is “too risky”?
Before we can address if reverse mortgages are bad, we need to first clear up how they work. There are a lot of misconceptions about reverse mortgages, so it’s important that we set the record straight first.
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What is a Reverse Mortgage?
A reverse mortgage is a unique home loan designed to give you access to home equity without a mortgage payment and without giving up ownership of your home.
The most popular reverse mortgage in America today is the FHA-insured and regulated home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders).
The minimum qualifying age for a HECM is 62. If you’re married, only one of you needs to be at least 62. The younger spouse can qualify as a non-borrowing spouse.
No mortgage payments are required as long as at least one borrower (or non-borrowing spouse) lives in the home and pays the property charges. The loan becomes due and payable when the last borrower or non-borrowing spouse permanently leaves the home.
You remain the owner of your home and you’re free to leave it to your heirs. Your heirs can keep the home by paying off or refinancing the reverse mortgage balance. If your heirs don’t want the home, they can sell it, repay the reverse mortgage, and keep the remaining equity.
Your heirs can also let the lender sell it if they don’t want to keep the home or mess with selling it.
The HECM is a non-recourse loan, which means the most that will have to be repaid is the value of your home. If your home isn’t worth enough to pay off the entire balance, FHA will cover the shortage.
The HECM is flexible and customizable; proceeds can be taken as a lump sum, line of credit, term/tenure income, or some combination of all of these options.
Homeowners commonly use the proceeds to eliminate existing mortgage and/or consumer debt payments, pay for home improvements, cover medical bills, or supplement existing retirement income and assets.
Why Are Reverse Mortgages Bad According to Some Financial Professionals?
The conversation with June wasn’t the first time I had heard a financial professional accuse reverse mortgages of being “risky”. I’ve heard all the rumors, concerns, and misconceptions at this point.
Here are the most common reasons accountants, attorneys, and financial advisors say reverse mortgages are bad, in my experience:
- You’ll give up ownership of your home
- You’ll lose your home
- The bank will get your house in the end
- You’ll lose all of your equity
- The rates are sky high
- The closing costs are sky high
But, are these allegations actually true? Let’s address each of them in turn:
- You’ll give up ownership of your home. This is simply not true. It’s just a home loan and you always remain the owner of your home. This is why you continue to pay the property taxes and homeowners insurance.
- You’ll lose your home. It’s pretty hard to put your home at risk with a HECM as long as you live in it, maintain it like normal, and pay your property taxes, homeowner’s insurance, and HOA dues (if applicable). These are normal obligations of homeownership whether you have a reverse mortgage or not. If you don’t pay your property taxes, your county will eventually foreclose. Even some HOAs have the power to file liens and/or foreclose if you don’t pay your HOA dues.
- The bank will get your house in the end. Not at all. Your heirs will get the home. They can keep the home by paying off or refinancing the loan balance. If they don’t want the home, they can sell it and keep the remaining equity once the reverse mortgage is paid off. They can also let the lender sell it if they don’t want to keep it or hassle with selling it.
- You’ll lose all of your equity. This is possible, but by no means a guarantee. If home values fall, you can lose all of your equity with other types of loans as well. Yes, it’s possible you can use up all of your equity, but that depends on how much you borrow. If you borrow less, you’ll preserve your equity for longer. If you borrower more, you could use up your equity faster. Regardless, the reverse mortgages is non recourse, which means FHA covers the shortage if your home isn’t worth enough to pay off the entire balance.
- The rates are sky high. Many people think reverse mortgages are bad because the interest rates are sky high. This simply isn’t true. HECM reverse mortgage rates are comparable to traditional “forward” mortgage interest rates.
- The closing costs are sky high. This is probably one of the most common reasons people think reverse mortgages are bad. Yes, the closing costs can be steep – mainly because of the IMIP that FHA charges to insure the loan. However, the closing costs are not always expensive. And even if they are, they’re usually not out of pocket. Like anything, you need to weigh cost versus benefit. If you’re a good candidate for a HECM, the benefits will easily outweigh the costs.
Here’s the bottom line: accountants, attorneys, and financial advisors generally mean well, but many think reverse mortgages are bad because of misconceptions about how they actually work.
A 2019 study by the Brookings Institution found a significant correlation between accurate information and a positive perception of the reverse mortgage. In other words, when seniors learn how a reverse mortgage really works, they like it – and they often choose to get one.
People generally don’t see reverse mortgages as “risky” when they learn how they actually work.
What Financial Professionals Often Recommend Instead
Financial professionals who think reverse mortgages are bad often recommend home equity lines of credit (HELOC) as an alternative. Yes, HELOCs are a legitimate way to tap into home equity, but are they a good idea for retirees? Let’s look at the advantages and potential risks of a HELOC.
Here are some potential advantages:
- Flexibility. You borrow only what you need when you need it.
- Low monthly payments. HELOC payments are usually interest-only.
- Minimal closing costs. HELOCs usually have minimal or no closing costs.
- Simpler application process. The process to get a HELOC is usually faster and simpler than a reverse mortgage.
Though they have a lot of advantages, HELOCs come with some downsides and risks:
- You must have good credit. Not all retirees have the credit needed to get a HELOC. If your credit has some dings, it may be tough to qualify.
- You must have adequate income. Many retirees on a fixed income don’t have enough income to qualify for a HELOC.
- Interest-only payments. This is why HELOC payments are low. You’re only paying the interest, which means you have to make extra payments to actually pay down the loan balance. And the more you borrow, the larger your payment gets.
- Adjustable rates. If rates increase, your payment will increase as well.
- Your lender can revoke, chop, or freeze your HELOC with little notice. Wells Fargo closed all of their outstanding HELOCs with almost no notice in the summer of 2021. Even people with high credit scores had their HELOCs revoked.
- The recast. Most HELOCs allow you to withdraw funds the first ten years of the loan. At the end of ten years, the bank recalculates the loan payment into a full principal and interest payment that repays the balance over the remaining loan term. This can cause your payment to double, tripe or quadruple.
In my opinion, HELOCs are best for short-term borrowing. You don’t want to maintain a large balance over the long term because of the recast. I’ve worked with seniors who ended up in foreclosure because their payment tripled at the end of the draw period.
How Is a Reverse Mortgage “Risky”?
Now that we’ve covered how reverse mortgages and HELOCs actually work, let’s explore whether a reverse mortgage is truly risky compared to a HELOC:
- A reverse mortgage has no monthly payment. If you have a HELOC, your payment increases as you borrow more and rates rise. Your payment could double or triple at the end of the draw period. If you can’t make your monthly payment, you risk foreclosure. With a reverse mortgage, no payment is required as long as you remain in good standing. You don’t have the payment risk associated with a HELOC or other cash out mortgage.
- A reverse mortgage is non recourse. If you have a HELOC, you’re on the hook for the shortage if your home value falls and you owe more than your home is worth. A reverse mortgage is non recourse, which means you’re not on the hook for the shortage if your home isn’t worth enough to pay off the entire balance.
- A reverse mortgage unlocks more cash for you to live on. The purpose of a reverse mortgage is to unlock more cash that you can use to finance your lifestyle and pay for unexpected expenses. Remember, June lives on just $1,300 per month. What’s truly risky is having no wiggle room in the budget and no extra savings for unexpected expenses. The reverse mortgage reduces financial risk.
- Reverse mortgage funds are always available as long as you remain in good standing. Unlike a HELOC, the available funds in a reverse mortgage can’t be locked, chopped, frozen, or taken away. You can count on the reverse mortgage to be there when you need it.
Are reverse mortgages bad really? Are they “risky”? How risky could a non recourse loan with no monthly payment be? I think a HELOC is far more risky for retirees on a fixed income than a reverse mortgage.
When a Reverse Mortgage May Not Be a Good Fit
Hopefully I’ve made the case that reverse mortgages are not bad or inherently risky. However, let me point out some situations where it may not be good fit:
- You want to leave the most home equity possible to your heirs. A reverse mortgage is designed to convert home equity into cash. If you want to leave the most home equity possible to your heirs, then a reverse mortgage isn’t a good fit.
- You plan to sell in the near future. You’re not locked into your home when you get a reverse mortgage, but it’s best for homeowners who don’t plan to move anytime soon. If you plan to sell in the next year or two, you may want to wait and do a reverse mortgage on the new home.
- You have a disabled relative living with you. A reverse mortgage may be unsuitable if you have a son or daughter or other relative living with you who can’t care for themselves. If something happens to you, they could lose the home if they can’t refinance or repay the reverse mortgage balance. Remember, the reverse mortgage balance becomes due and payable when you no longer live in the home and pay the property charges. If you have a disabled relative living with you, you may consider getting life insurance that can repay the HECM balance after you pass away.
- You get married after you get a reverse mortgage. This can be a potential reverse mortgage pitfall because your new spouse will not be considered a non-borrowing spouse and will not automatically “inherit” the protections built into the reverse mortgage. If something happens to you, your spouse will have to pay off or refinance the reverse mortgage balance or potentially give up the home. If you marry after getting a reverse mortgage, you may consider taking out a life insurance policy to protect against this possibility. You may also be able to refinance your reverse mortgage into a new reverse mortgage under both of your names.
If any of these situations apply to you, it may be best to avoid a reverse mortgage until your situation changes. A reverse mortgage is a great financial tool, but it’s not always the perfect solution for everybody. However, for the vast majority of retired homeowners, a reverse mortgage is safe and beneficial.
A Few Final Thoughts
So, are reverse mortgages bad? Definitely not! A reverse mortgage is a safe and beneficial mortgage product. The whole point of a reverse mortgage is to reduce financial risk in retirement.
It’s unfortunate that so many accountants, attorneys, and financial advisors still think reverse mortgages are bad and direct their clients into HELOCs.
A HELOC is a good loan product for short-term cash needs, but it’s risky to rely on a HELOC for cash over the long term, especially if you’re retired and living on a fixed income. I’ve worked with retirees who ended up in foreclosure because of their HELOC.
So, what’s riskier? A non recourse loan without a monthly payment or a loan with a monthly payment that could potentially double, triple, or quadruple at some point?
It’s unfortunate that so many financial professionals continue to think reverse mortgages are bad. When you look at how they work objectively, I think it’s pretty clear a reverse mortgage is a safe and beneficial option for many retirees.