You’ve heard all the great things about the HECM reverse mortgage, but there has to be some downsides, right? In this article, we’ll cover our take on the top five reverse mortgage disadvantages you’ve likely heard.
The reverse mortgage is a fantastic financial tool, but it’s not the right solution for everybody. There are some situations where a reverse mortgage may not make sense.
I’m an experienced reverse mortgage professional who has helped 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. 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.
Before we dig into the most commonly cited reverse mortgage disadvantages, let’s first cover a few basics about what a reverse mortgage is. Many of the supposed disadvantages you’ve heard may be based on misinformation about reverse mortgages.
What is a HECM Reverse Mortgage?
The most common reverse mortgage product in America is the home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders).
If you’re at least 62, the HECM enables you to convert a portion of your home’s value into tax-free cash. No mortgage payments are required as long as at least one borrower lives in the home and pays the required property charges.
The loan balance is due and payable when the last borrower permanently leaves the home, whether through selling, passing away, or moving into a nursing facility.
You always remain the owner of the home and you’re free to leave it to your heirs. Your heirs can pay off or refinance the loan balance if they want to keep the home. If they don’t want the home, they can sell it or let the lender sell it. Once the sale is complete, the remaining equity goes into your estate.
The HECM is a non-recourse loan, which means the most you or your estate will have to repay is the value of the home. FHA will cover the shortage if your home isn’t worth enough to cover the loan balance.
The HECM is highly versatile and comes with a variety of payout options. You can take the proceeds as a line of credit, lump sum, monthly term or tenure payment, or a combination of these options. Reverse mortgage borrowers commonly use the proceeds to get rid of existing mortgage or other debt payments payments, fund home improvements, or supplement existing income or retirement assets.
The Most Commonly Cited Reverse Mortgage Disadvantages
In the years I’ve done reverse mortgages, I’ve talked with many people and read numerous articles about reverse mortgages. The following are some of the most commonly cited reverse mortgage disadvantages that I’ve heard and read.
Disadvantage #1: You’re Giving Up Your Home
This is one of the most common reverse mortgage disadvantages I hear, but it’s a myth. You always remain the owner of your home, which is why you’re required to continue paying property taxes and homeowner’s insurance. If the lender owned the home, they would be paying the property taxes and insurance.
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 purpose of the reverse mortgage is to convert home equity into cash. So, yes, you’re going to use up home equity over time as the loan balance grows. That’s the purpose of the reverse mortgage.
Having said that, it’s important to understand that the program also preserves equity. It has to preserve equity or it’s not financially viable over the long term. Remember, the HECM reverse mortgage is a non-recourse loan. FHA covers the shortage if there’s not enough value in the home to settle the entire loan balance. If the HECM used up equity quickly, FHA would likely be covering a lot of shortages, which would make the program financially unworkable.
Again, this is a valid concern, but it’s somewhat overblown. Unless home values fall drastically, you’ll likely 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 see it as a disadvantage, per se. It’s more a question of suitability. The purpose of a HECM is to convert equity into cash. If you’re concerned about leaving as much equity as possible to your heirs, then a reverse mortgage is probably not the right option for you.
Disadvantage #4: The Closing Costs Are High
This is one of the most common reverse mortgage disadvantages that financial pundits cite. Yes, the closing costs can be high, but they’re not always high. Regardless of whether they’re high or not, closing costs can usually be rolled into the new loan. The exception is HECM for purchase; closing costs for a purchase HECM are paid out of pocket in addition to your down payment.
There are typically three categories of reverse mortgage closing costs:
- 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 (along with MIP) is what makes it possible for the HECM to be non-recourse.
- 3rd party closing costs: These are charged by the lender to cover the third party services needed to get your reverse mortgage done, including title, escrow, appraisal, credit report, etc.
Whether the closing costs are high or not, you may have some leeway to negotiate. If your starting loan amount is low, expect to pay at least some closing costs. If your starting balance is relatively high (such as when you’re paying off a large mortgage balance), the lender may have some leeway to cover all or part of the costs with a lender credit. Regardless, it doesn’t hurt to ask for a discount! The worst they can say is no, right?
Disadvantage #5: Interest Can Pile Up in the Later Years of the Reverse Mortgage
This is a valid concern and can be true if you start with a large loan balance and have the reverse mortgage for many years. Most HECM borrowers have their loan for around 7 years, so this likely won’t be a concern for most people.
Again, the HECM doesn’t require payments, so the accrued interest gets tacked onto the loan balance over time. The unpaid interest is considered a loan advance, which means that it accrues interest as well. You’re essentially 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 low. However, if you have the reverse mortgage for a lot of years, the interest can start piling up. It’s even possible for the balance to exceed your home’s value at some point.
If this sounds scary, keep a few things in mind. First of all, don’t forget the benefits offered by a reverse mortgage, including eliminating your mortgage payment, paying off other bills, remodeling your home, increased income, an emergency fund, etc. Yes, it’s important evaluate the costs, but don’t forget what you’re getting, too.
Secondly, whatever the eventual loan balance, your house will pay it back – even if it’s not worth enough to settle the entire balance. Remember, the HECM reverse mortgage is a non-recourse loan. You, your heirs, and your estate are not on the hook for the shortage if the home isn’t worth enough to settle the entire balance.
So, yes, interest can pile up in the later years when the loan balance is larger. However, if you don’t plan to sell your home and isn’t matter how much equity you leave to your heirs, don’t worry about.
Like any important decision, it’s important at both the upsides and downsides of a reverse mortgage. The HECM is a great loan product, but it’s not the perfect solution for everybody.
When friends and family warn you about the reverse mortgage disadvantages they’ve heard, remember that they mean well. However, do your own research and get all sides of the story. Once you have total picture, you can make an educated and informed decision about whether a reverse mortgage makes sense for you.