April 9, 2017 by HECM Pro
You’ve heard all the great things about the HECM reverse mortgage, but what are some reverse mortgage disadvantages? There has to be a catch, right? It can’t all be good, right ??
Though the reverse mortgage is a fantastic financial tool, it’s not necessarily the right solution for everybody. There are some situations where it may not make sense.
I’m an experienced reverse mortgage professional who has helped literally hundreds of people get reverse mortgages over the years. I’d like to set the record straight on some of the most common reverse mortgage disadvantages you may or may not have heard of. My goal is to help you become a more informed consumer so you can more easily decide if a HECM reverse mortgage is right for you.
But before we dig into the most commonly raised reverse mortgage disadvantages, let’s first cover a few basics about what a reverse mortgage actually is.
What is a HECM Reverse Mortgage?
The most common reverse mortgage product by far in America today is the Home Equity Conversion Mortgage, or HECM (often pronounced heck-um by industry insiders). If somebody you know recently got a reverse mortgage, it’s a good bet they got a HECM.
If you’re a homeowner 62 years of age or older, a HECM reverse mortgage can enable you to convert a large portion of the value of your home into tax-free cash without a monthly payment and without giving up ownership of your home. As long as at least one borrower is living in the home and paying the property taxes and insurance, no payment is required on any of the money you use and the loan does not have to be paid back. The loan only becomes due and payable when the last borrower permanently leaves the home, whether through selling, passing away, or moving into a nursing facility. As long as you meet your obligations under the program, there’s no way you can get into trouble with a reverse mortgage.
The HECM is a non-recourse loan, which means that the most that will ever have to be repaid is the value of the home – even if it’s not enough to settle the entire loan balance. This means that you, your heirs, or your estate are not on the hook for any kind of shortage if there’s not enough value in the home to pay off the entire loan.
Because the reverse mortgage is a type of home loan, naturally, it accrues interest over time. If you choose not to make any kind of monthly payment, the interest just accrues onto the loan balance at an annual rate that is usually pretty comparable rates for traditional mortgages.
Proceeds can be used for just about anything. Many reverse mortgage clients use the reverse mortgage to get rid of existing mortgage payments, other debts, do home improvements, or supplement existing income or retirement assets.
The Most Commonly Cited Reverse Mortgage Disadvantages
In the years that I’ve done reverse mortgages I’ve talked with a lot of people and read plenty of articles by pundits and financial experts about the product. The following are some of the most commonly cited reverse mortgage disadvantages that I’ve heard and read.
Though I’m an industry insider who makes his living off of this product, I will do my best to give as unbiased an opinion as possible on each of these commonly raised concerns.
Disadvantage #1: You’re Giving Up Your Home
This is one of the most common reverse mortgage disadvantages I hear from homeowners first inquiring about a reverse mortgage, but it’s simply a flat-out myth. You always remain the owner of your home when you get a HECM reverse mortgage. This is why you’re required to continue paying property taxes and insurance as part of your obligations under the program. If the lender owned the home, they would be paying the property taxes and insurance.
Because you’re the owner, you’re also free to leave the home to your heirs. If your heirs don’t want the home and don’t want to hassle with selling it, the lender steps in to sell the home, pay back the reverse mortgage balance, and any equity left over goes to your heirs.
Disadvantage #2: You’ll Use Up All of Your Equity
Yes, it’s theoretically possible to use up all of your equity, but this perceived disadvantage is a bit overblown. First of all, the whole purpose of the reverse mortgage is convert home equity into cash. So of course you’re using up home equity over time as your loan balance grows. That’s the whole point of the reverse mortgage program.
Having said that, it’s important to understand that the program also preserves equity. It has to or it’s not financially viable over the long term. Remember, the HECM reverse mortgage is a non-recourse loan. FHA has to cover the shortage if there’s not enough value in the home to settle the entire loan balance at the time it’s due and payable. If the reverse mortgage used up equity quickly, it’s a good bet FHA would be covering a lot of shortages, which would make the program completely unworkable from a financial standpoint.
Again, this is a valid concern, but it’s somewhat overblown. Unless home values fall drastically, it’s a good bet you would have plenty of equity left in your home for many years to come.
Disadvantage #3: You Won’t Leave Any Equity to Your Heirs
This is one of the more common reverse mortgage disadvantages I hear, but I don’t really see it as a disadvantage per se. It’s more a question of suitability. The whole purpose of the reverse mortgage is to convert equity into cash, so if you’re concerned about leaving as much equity as possible to your heirs, the reverse mortgage is not the right program for you.
Disadvantage #4: The Closing Costs Can Be High
This is one of the most common reverse mortgage disadvantages cited by financial experts and pundits, but it can be somewhat overblown. Yes, the closing costs for a reverse mortgage can be higher than a traditional forward mortgage, it doesn’t mean they actually will be. And even if they are, it’s important to remember that you typically don’t need to pay them out of pocket. The vast majority of the closing costs are just included in the new loan amount and repaid when the loan is settled at some point in the future.
There are typically three categories of closing costs for a reverse mortgage:
- Origination: Charged by lenders to cover their overhead and pad the bottom line.
- IMIP mortgage insurance: Charged by FHA to insure the HECM reverse mortgage. IMIP makes it possible to never make a mortgage payment and it’s what protects you if the home isn’t worth enough to settle the entire loan balance in the future.
- 3rd party closing costs: Services hired by the lender to get your reverse mortgage done, such as title, escrow, appraisal, credit report, etc.
One of the biggest cost drivers is the IMIP, which can be assessed at a stiff 2.50% of the maximum claim amount (which is usually equal to the appraised value for most people) if you’re paying off a large loan balance. If the maximum claim amount is $400,000, then the IMIP would be a whopping $10,000.
On the other hand, if the starting balance is very low (such as when there’s little to nothing owed on the home), the IMIP could be a comparatively small 0.50% of the maximum claim amount. On the same $400,000 home, that would be just $2,000.
If your starting balance is very low, expect the lender to charge some kind of origination and pass on to you the IMIP and the 3rd party closing costs. If your starting loan balance is relatively high (as in cases where you’re paying off a large mortgage balance), the lender may have some leeway to cover all or part of your closing costs with a lender credit.
Whether or not your lender can offer some kind of discount depends on the loan amount, the current interest rate environment, and lender policy, but it never hurts to ask. The worst the can say is no, right?
Though closing costs are just a reality when getting a reverse mortgage, the good news is that the vast majority of them typically don’t need to be paid out of pocket. They can just be rolled into the new loan amount. The only costs that are typically out of pocket are counseling fees (average $125) and appraisals. If you ask, the lender may even be willing to cover all or part of the appraisal for you.
Disadvantage #5: Interest Can Really Pile Up in the Later Years of the Reverse Mortgage
This is a completely valid concern and can be true if you have the reverse mortgage for many years and you use most or all of the money early in the life of the loan. However, the average amount of time somebody has a reverse mortgage is about seven years, so this is one of those reverse mortgage disadvantages that may never impact you anyway. You may not have the loan long enough for it to become an issue.
As I mentioned already, any interest you don’t pay out of your pocket is added to the loan balance over time. Any interest added to the loan balance is considered an advance from the reverse mortgage, which means that it accrues interest as well. You’re basically accruing interest on top of interest over time.
This isn’t a big deal in the early years of the loan because the balance is relatively low. However, if you have the reverse mortgage for 15 or 20 years or more, the interest can really start piling up. It’s even possible the loan balance could outgrow the value of the home.
Now, this might sound scary at first, but it’s important to keep things in perspective. First of all, don’t forget the great financial and lifestyle benefits you received from the reverse mortgage, whether it’s the elimination of a mortgage payment, the payoff of other bills, a remodeled house, more income, an emergency fund, etc. It’s important to remind yourself of what you received, not just what’s going to be paid back someday.
Second, whatever the loan balance ends up being, the house is going to pay it back. You don’t have to out of your income or other assets. On top of that, don’t forget that the most that ever has to be paid back is the value of the home – even if the home isn’t worth enough to settle the entire balance. Remember, the HECM reverse mortgage is non-recourse loan. You, your heirs, or your estate are not on the hook for the shortage if the home isn’t worth enough to settle the entire balance.
So, yes, the interest can definitely pile up in the later years when the loan balance grows pretty large. However, you don’t have to pay it. If you never plan on selling the home and you don’t care how much equity you leave to your kids, in some ways it doesn’t really matter what your loan balance is in a practical day-to-day sense. And hopefully you received something very positive in the meantime from the money you got from the reverse mortgage.
Like any big decision in life, it’s important to look at the entire picture when evaluating whether a reverse mortgage makes sense for you. Though the HECM reverse mortgage is not the perfect solution for absolutely everybody, it’s a fantastic product that makes a positive difference for a lot of people. When people are passionately telling you of all the reverse mortgage disadvantages they’ve ever heard about, it’s important to understand that they mean well, but many times what they’ve heard is either overblown or complete misinformation. It’s important to look into it yourself and get the straight deal about the pros and cons, how it could benefit you, and what the costs are. Once you have all the information, you can make an educated and informed decision about whether a reverse mortgage is the right option for you.