You’ve probably seen the reverse mortgage commercials with Henry Winkler and Tom Selleck. They make reverse mortgages sound pretty good, don’t they? But is a reverse mortgage as good as they say? Are there some reverse mortgage pitfalls that you need to watch out for?
I’m a highly experienced mortgage industry veteran who has helped many seniors get reverse mortgages over the years. There is a lot of misinformation out there about reverse mortgages. Many of the pitfalls you’ve heard about are actually misunderstandings about how reverse mortgages work. We’ll set the record straight on those, then we’ll cover some genuine pitfalls that you may need to watch out for.
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How Does a Reverse Mortgage Work?
A reverse mortgage is a unique mortgage product that offers homeowners 62 and older access to home equity without giving up home ownership or taking on a mortgage payment.
The most popular reverse mortgage in the United States is the home equity conversion mortgage, or HECM (commonly pronounced heck-um by industry professionals).
The HECM was signed into law by President Reagan as part of the Housing and Community Development Act of 1987. Today, it’s regulated and insured by the Federal Housing Administration (FHA) and the Department of Housing and Urban Development (HUD).
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. FHA covers any shortage if your home isn’t worth enough to pay off the entire balance.
The HECM is flexible and customizable; your lender will tailor it to your individual financial goals and needs. You can take proceeds as a lump sum, line of credit, term/tenure income, or some combination of these options.
Seniors commonly use reverse mortgage proceeds to eliminate existing mortgage or other debt payments, fund home improvements and repairs, pay medical bills, supplement income, and supplement retirement assets.
How much you qualify for depends on your age, home value, current interest rates, and the HECM program you select. Older borrowers tend to qualify for more than younger borrowers.
Let’s Clear Up Some Rumors Right Off the Bat
Now that we’ve covered the basics, let’s set the record straight on a few supposed reverse mortgage pitfalls you may have heard about:
- You remain the owner of your home. The bank isn’t taking over your house, which is why you continue to pay the property taxes and homeowner’s insurance.
- You’re not selling your house to the bank for a discount. Again, it’s just a home loan. The bank is lending you a portion of the value of your home.
- The bank does not get the house in the end. You’re free to leave it to whoever you like and they’ll inherit the equity in the home.
- You won’t leave a big debt for your heirs to clean up. FHA covers the shortage if the home isn’t worth enough to pay off the entire balance.
- You’re not required to repay the loan when it reaches a certain balance or if you run out of equity. Again, no repayment is required for as long as at least one borrower or non-borrowing spouse lives in the home and pays the required property charges.
Does the reverse mortgage I’ve described so far sound different than what you’ve heard about? If so, you’re in good company! The HECM reverse mortgage is a highly misunderstood financial product. That’s why it’s important to be careful who you listen to when considering a reverse mortgage.
Friends and family mean well, but the advice they offer is often based on the rampant rumors and misconceptions that continue to circulate. Many of the reverse mortgage pitfalls you hear about are actually based on misconceptions about how reverse mortgages work.
A Reverse Mortgage is Not Risky
A HECM reverse mortgage is a very safe mortgage product. It’s pretty hard to get into trouble with a reverse mortgage as long as it’s a good fit and you remain in good standing. Again, here are your obligations:
- Live in the home
- Pay the property taxes (and any applicable special assessments)
- Pay the homeowner’s insurance (and flood insurance, if applicable)
- Pay your HOA dues (if applicable)
- Maintain your home like you normally would
These are all normal things that homeowners do anyway, right? As long as you uphold your end of the bargain, it’s pretty hard to get into trouble with a reverse mortgage.
Again, no repayment is required as long as you remain in good standing. There’s no time limit on that, either.
And don’t forget that the reverse mortgage is non-recourse. You’re protected even if home values fall and you owe more than your home is worth. FHA covers the shortage. I don’t know of any other mortgage product that does that.
Again, the HECM is very safe for the vast majority of retirees. Many reverse mortgage pitfalls are, in reality, misconceptions about how they work or questions of suitability – not genuine faults with how the reverse mortgage works.
What Are the Pitfalls of a Reverse Mortgage?
According to Merriam-Webster, a pitfall is “a hidden or not easily recognized danger or difficulty”. In the case of a reverse mortgage, a pitfall would an unusual negative circumstance caused by the reverse mortgage that would relatively difficult to anticipate.
So, what are the pitfalls of a reverse mortgage? To answer that, let’s first cover a few things that people say are pitfalls, but really aren’t.
Normal features or functions that simply make the reverse mortgage a bad fit are not reverse mortgage pitfalls. No financial product is perfect for everybody. If it’s not perfect for you, it doesn’t mean it’s a bad product – it’s just the wrong product for you.
Here are some examples of reverse mortgage pitfalls that really aren’t pitfalls:
- You’ll leave less (or maybe zero) equity to your heirs. The whole purpose of a reverse mortgage is to convert home equity into cash. This means the balance will increase and your equity will decrease over time. This is how a reverse mortgage is supposed to work. If you want to leave the most equity possible to your heirs, then a reverse mortgage isn’t the right fit for you. This isn’t a reverse mortgage pitfall.
- You risk triggering a maturity event if you don’t pay the property charges. Any mortgage lender will require you to pay your property charges. This is a normal obligation of homeownership. If you don’t pay your property taxes, your county will eventually foreclose on you, right? Even HOAs can file liens or foreclose if you fail to pay your HOA dues. Paying your property charges on time is important to avoid a maturity event that could cause your reverse mortgage to become due and payable. Triggering a maturity event because you failed to pay the property charges isn’t a reverse mortgage pitfall.
Now that we’ve covered some basics and laid to rest a few supposed reverse mortgage pitfalls, let’s get into some genuine reverse mortgage pitfalls that I’ve run across over the years.
10 Little-Known Reverse Mortgage Pitfalls
The following reverse mortgage pitfalls come up rarely, in my experience. These situations won’t apply to the vast majority of reverse mortgage borrowers, so they’re likely not something you’ll need to worry about. But since you’re asking, here goes!
- Getting 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.
- 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.
- Leaving your younger spouse off the reverse mortgage to qualify for more money. It’s not as easy to do this as in the past, but it’s a dumb idea and a self-inflicted reverse mortgage pitfall. Proceeds are calculated based on the youngest of the two spouses (even if one spouse is a non-borrowing spouse), so some borrowers in the past chose to leave off their younger spouse to get more money. If the older spouse passed away, the younger spouse was was forced sell the home if they couldn’t pay off or refinance the loan balance.
- You’re not financially able to pay your property charges and maintain your home. FHA requires lenders to qualify applicants based on income and credit. Of course, lending guidelines aren’t perfect. It’s possible for applicants to be approved who really don’t have the financial ability to live in and maintain their home. If you really can’t afford to pay the property charges long term, you probably should avoid a reverse mortgage or consider taking a LESA. You don’t want to fail to pay your property charges and trigger a maturity event.
- One borrower isn’t financially responsible. A reverse mortgage gives you access to a potentially huge amount of money. All borrowers on the reverse mortgage have full access to the funds. If one borrower is financially irresponsible, it may be a bad idea to get a reverse mortgage.
- Disability income and Medicaid. If you have asset or income-based government benefits, make sure you fully understand how a reverse mortgage could impact them. Most of the time, you just need to be careful about how much money you maintain in your bank accounts. However, other requirements could apply. You don’t want to jeopardize any benefits you’re receiving by not managing the reverse mortgage correctly.
- Changing title after the reverse mortgage is complete. Changing the title ownership after the reverse mortgage is complete could potentially trigger a maturity event. Make sure to check with your servicer before you change the title owners of your home.
- Paying your line of credit to a zero balance. This isn’t a common pitfall, but it can come up for borrowers trying to maximize their line of credit growth. Avoid paying your line of credit to a zero balance because it will close it out completely. Contact your servicer to confirm the minimum balance needed to keep your line of credit open.
- Late property tax, homeowner’s insurance, or HOA payments at application. This is a pitfall that occurs frequently during the reverse mortgage application process. FHA requires your lender to document the last 24 months of property tax, homeowner’s insurance, and HOA payments to make sure you paid them on time. Even if the payments were late just a day, it can cause problems when applying for a reverse mortgage. If you plan to apply for a reverse mortgage, make sure you pay your property taxes, homeowner’s insurance, and HOA dues before the due date.
- Pulling all the money out and dumping it into your savings account. Some reverse mortgage borrowers still insist on pulling out all the funds and dumping them into their bank account. This is a mistake and a self-inflicted reverse mortgage pitfall. If you have a lot of money still available on your reverse mortgage line of credit, it’s far better to leave it there. For one, you’ll keep your loan balance lower, which means it accrues less interest. You’ll also be keeping more money in the line of credit where it can grow and compound larger, which gives you access to more money over time. And let’s not forget that banks pay very little interest on savings accounts, so there’s no point in keeping a lot money there. The line of credit growth is typically better than the rates banks pay on savings.
Some Final Thoughts
Hopefully what I’ve covered here puts your mind at ease about reverse mortgages and the reverse mortgage pitfalls you’ve been hearing about. There is a lot of misinformation circulating about reverse mortgages. It’s great that you’re taking the time to do your homework before getting into one.
Many of the reverse mortgage pitfalls you’ve heard about are, in reality, misconceptions about how reverse mortgages work. Other pitfalls are really issues of suitability, not actual problems with how a reverse mortgage works. Most actual pitfalls of reverse mortgages apply only to a small number of applicants, which means most people don’t need to worry about them.
The reverse mortgage is a great financial product, but it’s not always the right solution for everybody. If it’s not a good idea for you, it doesn’t mean it’s a bad product riddled with reverse mortgage pitfalls.
A HECM reverse mortgage is a very safe loan for the vast majority of retirees. As we’ve covered, your end of the bargain is to live in the home, pay the property charges, and maintain the home like you normally would. As long as you do that, it’s tough to get into trouble with a reverse mortgage.
If home values fall and you somehow end up owing more than your home is worth, FHA will cover the shortage so you don’t leave a big mess for your heirs to clean up.