Are Reverse Mortgages Expensive? The Answer May Surprise You

Many people have the impression that reverse mortgages are expensive. In fact, this is one of the most common objections to a reverse mortgage. You may be surprised at how reverse mortgage costs compare to other common financial products.

Are Reverse Mortgages Expensive?

I was prompted to write this post when I came across an old email from a gentleman critical of an article I wrote about the reverse mortgage line of credit.

He believed I was painting too rosy of a picture of the line of credit growth and downplaying the “exorbitant” (his word) costs of the reverse mortgage.

It’s unfortunate he felt that way, because the line of credit is one of the best features of a reverse mortgage. Used strategically, it can be a gamechanger for homeowners who owe little to nothing on their homes and don’t need the proceeds right away.

Is my critic correct? Are reverse mortgages expensive? Well, first of all, it depends on what you’re referring to. If you’re talking about just closing costs, then yes, reverse mortgages are expensive compared to other mortgage products.

However, if you’re referring to the overall cost of a reverse mortgage, you may be surprised to learn that reverse mortgages are often comparable to other mortgage and financial products.  

Reverse Mortgage Basics

A reverse mortgage is a unique home loan that enables homeowners 62 and older to convert home equity into cash without a mortgage payment and without giving up ownership of their homes.

The most popular reverse mortgage in America is the FHA-insured home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). 

No mortgage payments are required as long as at least one borrower (or non-borrowing spouse) lives in the home and pays the required property charges.

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, pay off the loan, and keep the remaining equity.

The HECM is a non-recourse loan, which means the most that will have to be repaid is the value of your home. FHA covers the shortage if your home isn’t worth enough to pay off the entire balance.

Typical Reverse Mortgage Costs

A HECM reverse mortgage is a home loan, so it comes with an interest rate and closing costs.

HECM interest rates are very reasonable; they’re typically comparable to 30-year rates for traditional “forward” mortgages.

How much interest you ultimately pay for a reverse mortgage depends on how you use it. If you borrow a lot at the start of the loan (to pay off an existing mortgage, for example), then your interest costs will be higher than if you borrow very little at the start of the loan.

We’ll cover some examples of how this works a little later.

The reason people consider reverse mortgages expensive is the closing costs. And, yes, it’s true that reverse mortgage closing costs are typically higher than closing costs for traditional “forward” mortgages.

The largest reverse mortgage closing cost is the IMIP, which is charged by FHA to insure the reverse mortgage and make it non recourse.

As of this writing, the IMIP equals 2% of the maximum claim amount (the lesser of your home’s value or the lending limit). For example, if the maximum claim amount equals $300,000, the IMIP equals $6,000 (2% * $300,000).

IMIP can get pretty expensive if you live in a high cost real estate market where homes are valued at $700,000 to $800,000 or more.

Lenders also charge origination fees, which range from $2,500 to $6,000, depending on the value of your home. 

Third party costs typically add another $2,000 to $5,000 to the closing cost total.

As you can see, the closing costs for a reverse mortgage are expensive. But the good news is that most lenders will roll them into the new loan; they don’t have to be paid out of pocket unless you’re purchasing a home with a reverse mortgage.

Now, let’s see if reverse mortgages are expensive compared to some other common financial products. We’ll cover the potential costs of a 401(k), FHA mortgage, and conventional mortgage to see how a reverse mortgage stacks up.

401(k) Cost Example

Most Americans don’t think twice about using a 401(k) plan to save for retirement. Investing in a 401(k) is widely considered to be a wise financial move – especially if your employer offers a match.

According to Investopedia, the average fees on a 401(k) range from 0.5% to 2%, depending on the size of the plan. These fees are assessed as a percentage of the total dollars under management on an annual basis for as long as the 401(k) plan exists.

In other words, if your 401(k) has a 1% fee, that means 1% of your return is skimmed off by the plan custodian every year for life of the 401(k). As we’ll see, annual fees can add up to a lot of money if you have a 401(k) for 20 or 30 years.

To show you how much these fees can cost over time, let’s assume three different workers invest $100,000 at age 35. Worker #1 has a plan fee of 0.5%, worker #2 has a plan fee of 1%, and worker 3 has a plan fee of 2%.

To keep things simple, we’ll assume all three workers make no further investments and earn a consistent return of 8% per year. Here’s what each worker would end up with after 30 years:

Worker	Plan Fee %	Total Fees	Final Balance
Worker #1	0.5%	$50,029	$936,302
Worker #2	1.0%	$179,388	$806,943
Worker #3	2.0%	$387,070	$599,261

If there were zero fees, each of these plans would have a balance of $1,086,331. That means each worker earned $986,331 on their initial $100,000 investment over their working careers.

As you can see, worker #1 ended with a balance of $936K, which means he paid $50,000 in fees over the life of his 401(k). Worker #2 paid about $179K in fees and worker #3 paid a whopping $387K in fees!

Keep in mind that management fees are collected regardless of your annual return. Even if your 401(k) loses money, you’ll still pay the management fee.

Does this mean 401(k)s are bad? Not at all! I’ve invested in a 401(k) myself. Sure, nobody likes to pay fees, but they’re the cost of doing business when you invest in a 401(k). You’re paying for the benefits that a 401(k) offers: easy investing, company match, diversification, favorable tax treatment, and professional management.

So, are reverse mortgages expensive compared to a 401(k)? Not necessarily! Again, we’ll cover some reverse mortgage total cost scenarios a little later.

FHA Mortgage Cost Example

Now, let’s see if reverse mortgages are expensive compared to a traditional “forward” FHA mortgage.

FHA mortgages are popular for first-time homebuyers because they offer low down payments and more flexible lending standards than other home loan products.

For this example, let’s assume a $300,000 purchase price, a minimum down payment of 3.5%, and a 30-year fixed interest rate of 3.50%.

FHA charges an upfront mortgage insurance premium, which equals 1.75% of the loan amount as of this writing. Most buyers finance the FHA insurance, so we’ll assume that here as well.

The starting loan amount, including the FHA insurance, equals $294,566.

FHA also charges an annual mortgage insurance premium of 1.05% for the life of the loan that is paid as part of the monthly mortgage payment.

Closing costs vary widely, but we’ll assume $5,000 for this example.

Let’s see how the overall costs of this loan add up:

Cost	Amount
Upfront mortgage insurance:	$5,066
Closing costs:	$5,000
Lifetime interest:	$181,618
Lifetime annual mortgage insurance:	$48,954
Total lifetime cost:	$240,638

As you can see, it costs this borrower a whopping $240,638 over the life of the loan to borrow $294,566 via a traditional FHA loan.

So, are reverse mortgages expensive compared to a traditional “forward” FHA loan? Not necessarily!

Now, if you’re not a first time homebuyer and/or you have excellent credit, an FHA loan probably isn’t the option you would go with. Let’s also take a look at a conventional loan.

Conventional Mortgage Cost Example

If you have excellent credit and a large down payment, a conventional loan is probably a better option if you’re purchasing a home.

Conventional loans don’t have mortgage insurance if you put down at least 20% of the purchase price, but the interest rates tend to be higher than rates for FHA mortgages.

For this example, let’s assume the same $300,000 purchase price, a 20% down payment (which means we’re financing $240,000) and an interest rate of 4.50% for a conventional 30-year fixed mortgage.

As before, we’ll assume $5,000 for the closing costs.

Let’s see how much the loan costs add up to:

Cost	Amount
Closing costs:	$5,000
Lifetime interest:	$197,776
Total lifetime cost:	$202,776

As you can see, it costs a total of $202,776 to borrow a fairly modest $240,000 over 30 years with a conventional mortgage. That’s a lot of money!

Many commentators and pundits who consider reverse mortgages expensive wouldn’t think twice about taking out a conventional mortgage like this one.

Reverse Mortgage Cost Examples

So how do the costs of the 401(k), FHA mortgage, and conventional mortgage stack up to the total costs of a reverse mortgage? Let’s check out some examples to see if reverse mortgages are expensive compared to these other common financial products.

Free and Clear With a Line of Credit Payout

For this first example, let’s assume we have a 62-year old borrower with a free and clear home valued at $600,000.

This borrower doesn’t need the money right now, so he plans to set up a line of credit and use it as a safety net. The goal is to leave the line of credit untouched as long as possible to maximize the growth.

Let’s assume this borrower qualifies for a principal limit equal to 45% of the value of the home, which equals $270,000.

Let’s also assume the closing costs are $12,000 for the IMIP, $6,000 for the origination, and $2,000 for the third party costs, which totals $20,000.

What?? Twenty thousand dollars for closing costs?? I can hear my email critic gasping at the thought of paying $20,000 to get a mortgage. Yes, I agree, reverse mortgages are expensive when it comes to closing costs – but that’s only part of the picture.

Let’s also assume the total initial interest rate and MIP add up to an annual rate of 5%. To keep the example simple, we’ll assume the interest rate never changes and the borrower doesn’t take any additional cash over 30 years.

Let’s see how the numbers work out if this borrower has his reverse mortgage until he’s 92:

Cost	Amount
Closing costs:	$20,000
Lifetime interest and MIP:	$68,984
Total lifetime cost:	$88,984

Over 30 years, the reverse mortgage costs a total of almost $89,000. Obviously not chump change, right? But let’s also look at the other side of the equation: what is this borrower getting for that $89K?

The line of credit has been growing and compounding over the 30 years he’s had the loan. At age 92, the line of credit will have grown from a net $250,000 ($270,000 principal limit minus $20,000 in closing costs) to a whopping $1,112,301.

This borrower has over $1 million at his disposal to use for whatever he needs on a non-recourse basis. Wow!

Now, granted, it’s probably not realistic that he won’t use the money for three full decades. So, let’s see how the numbers work out if he pulls out $150,000 at age 77 to pay off some bills, remodel his kitchen, and have some fun. This means his available line of credit will drop by $150,000 and his interest and MIP costs will increase because the loan balance will be larger. 

Here’s how the costs add up at age 92:

Cost	Amount
Closing costs:	$20,000
Lifetime interest and MIP:	$253,414
Total lifetime cost:	$273,414

As you can see, the total lifetime costs are much higher because the loan balance increased substantially at the 15-year mark. However, let’s not forget a few important points:

• This homeowner still has a line of credit, which has grown to a massive $797,871.
• He also got $150,000 in cash without having to make any monthly payments. That’s saved him around $700 per month for the last 15 years versus borrowing the money from a traditional “forward” mortgage.

Here’s the bottom line: this homeowner incurred around $273K in costs over 30 years to get $150,000 in cash and a $797K line of credit without having to make any mortgage payments.

Yes, the costs are not inconsequential, but they’re comparable to the 401(k) and mortgage examples we’ve already looked at. More importantly, this borrower got a lot for what he paid, in my opinion.

Paying Off a Large Mortgage Balance

Now, let’s check out a scenario where we’re paying off a large mortgage balance, which means the interest costs over time will be significantly higher than for somebody who starts with a free and clear home.

For this example, let’s assume a 62-year old borrower and a home worth $600,000. Let’s also assume this borrower purchased the home a year ago with a 3.50% 30-year fixed mortgage that started at $250,000.

The principal and interest payment equals $1,122.61 per month. We’ll leave out the property taxes and insurance because you have to pay those regardless of the type of mortgage you have (or whether you have a mortgage at all).

After a year’s worth of payments, this borrower’s mortgage balance is now down to $245,202.

As before, let’s assume $20,000 in closing costs, which will be rolled into the new reverse mortgage balance, which means the starting loan amount will be $265,202.

Let’s also assume the same combined interest and MIP rate of 5%.

Let’s see how things look at age 91 when the 30-year fixed mortgage would have otherwise been paid off:

Cost	Amount
Closing costs:	$20,000
Lifetime interest and MIP:	$861,984
Total lifetime cost:	$881,984

Wow, that total cost figure is pretty ugly, right? The loan balance has increased a lot over the years.

If this borrower’s home hasn’t appreciated in value, the loan balance may even be more than the value of the home. Fortunately, the HECM is non-recourse, so FHA will be on the hook for any shortage if the home isn’t worth enough to pay off the entire balance.

Now, here’s the kicker: this borrower hasn’t had a mortgage payment for 29 years. Twenty-nine year’s worth of mortgage payments at $1,122.61/month adds up to a massive $390,668. That’s $390K that this borrower saved and was able to spend on fun activities with grandchildren, home improvements, travel, covering medical expenses, etc.

When you figure in the mortgage payment savings, the total cost of the reverse mortgage drops to a net $491,316. That’s not an insignificant number, but we’re also assuming this borrower keeps the reverse mortgage for 29 years – which is a very long time. Most seniors have their reverse mortgages for about 7-8 years.

As you can see, reverse mortgages can be more expensive when you start off with a high loan balance. The total interest and closing costs were pretty high in this scenario, but this borrower also saved $390,668 that would have otherwise gone to mortgage payments.

It Comes Down To Cost Versus Benefit

Folks, like anything, it’s all about cost versus benefit. A HECM reverse mortgage has costs like anything else. When you look at the total picture, as we’ve done here, the costs are often not that different compared to the total costs of a 401(k)s or traditional “forward” mortgage.

Here’s a recap of the total costs for all the examples we’ve covered:

Example	Cost
401(k) Worker #1:	$50,029
401(k) Worker #2:	$179,388
401(k) Worker #3:	$387,070
FHA mortgage:	$240,638
Conventional mortgage:	$202,776
Reverse mortgage w/ line of credit:	$88,984
Reverse mortgage w/ $150K withdrawal:	$273,414
Reverse mortgage w/ mortgage payoff:	$491,316 (after payment savings)

As you can see, it’s not a given that reverse mortgages are expensive compared to other common financial products.

While costs are important, it’s also important to look at benefit. What does a reverse mortgage offer you? What are you getting in return for the costs?

If a reverse mortgage significantly improves your lifestyle and financial security, the costs are probably well worth it. Of course, that’s a judgment call only you can make.

Some people decide that the costs aren’t worth it. That’s OK! That doesn’t mean the reverse mortgage is bad, it just means a reverse mortgage isn’t perfect for everybody.

Frequently Asked Questions