What are the dangers of reverse mortgage financing? Is a reverse mortgage risky? If so, what are the risks? We’ll cover what you should and shouldn’t be concerned about.
Questions like these come up from time to time and I always find them puzzling. Honestly, I don’t see a reverse mortgage as risky. Yes, it might be a poor fit for some people, but calling it “risky” or “dangerous” is a stretch, in my opinion. As I’ll show you, a traditional “forward” mortgage actually can be far riskier for seniors than a reverse mortgage.
I think a lot of people see reverse mortgages as risky simply because they don’t understand how they actually work. There is a ton of misinformation floating around out there about reverse mortgages. If half of the myths I’ve heard over the years were actually true, I would probably agree that reverse mortgages are risky.
Before I dig into some of the supposed dangers of reverse mortgages, let me first cover some basics. If you’re already familiar with the basics, feel free to skip past this next section.
Reverse mortgage basics
The most common reverse mortgage in America today is the FHA-insured home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders).
The HECM enables homeowners 62 or older to convert a portion of their home’s value into cash without giving up ownership of the home or taking on a mortgage payment.
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. The reverse mortgage only has to be repaid when the last borrower permanently leaves the home.
You always retain title ownership of the home and you’re free to leave it to your heirs, who will inherit any equity remaining in the home. If your heirs wish to keep the home, they can pay off or refinance the balance. If they don’t want to keep the home, they can sell it, pay back the reverse mortgage, and keep the remaining equity.
The HECM is a non-recourse loan, which means the most that will ever have to be repaid is the value of the home. If the home isn’t worth enough to pay off the entire balance, FHA will pay the shortage.
The HECM is very versatile and can be tailored to your individual financial goals and needs. Proceeds can be received in the form of a line of credit, lump sum, monthly term or tenure income, or some combination of all of these options.
Seniors commonly use reverse mortgages to get rid of existing mortgage or other debt payments, finance home improvements, or supplement existing retirement income or assets.
Where’s the risk?
Based on what we’ve covered so far, what are the dangers of reverse mortgage financing? Where’s the risk? How risky can a reverse mortgage be when you don’t have to make a monthly mortgage payment?
In my opinion, a traditional “forward” mortgage with a payment is far riskier when you’re living on a fixed income in retirement. If you stop making your payments, you could lose your home to foreclosure.
Yes, the reverse mortgage program requires you to keep up with your property charges. But you have to do that when you own a home anyway. If you fail to pay your property taxes, the county will eventually foreclose on you. If you fail to pay your homeowner’s insurance, you risk losing everything if your home burns down.
The reverse mortgage requires you to continue doing what you already are: pay the required property charges and live in the home and maintain it. As long as you do that, it’s pretty hard to get into trouble with a reverse mortgage.
Let’s also not forget that the HECM reverse mortgage is a non-recourse loan. If home values fall and you owe more than the home is worth, you and your heirs are not on the hook for the shortage. FHA covers the shortage.
A financial safety net
The way I see it, a reverse mortgage reduces financial risk in retirement. It’s a safety net that helps protect and preserve your lifestyle and financial security.
Think about it: what if you have a traditional mortgage (with a payment) and get into a financial bind? Will your lender care that you can’t afford your mortgage payment because you’ve been hit with medical bills? Probably not, right? You’d better keep paying that mortgage or the bank will take your house.
The reverse mortgage eliminates this risk. When you no longer have a mortgage payment, your home is secure from mortgage payment risk.
There are far more “forward” mortgage dangers for retirees than reverse mortgage dangers, in my opinion.
If your home is free and clear, you can structure the reverse mortgage like a tax-free retirement account that grows larger over time. This serves as a financial safety net that protects your lifestyle and financial security against sequence risk, unexpected expenses, loss of income, expensive home repairs, and a rising cost of living.
When you’re retired, you don’t have the ability to earn the way you did in your working years. That’s why it’s essential to have as many financial resources at your disposal as possible. The reverse mortgage unlocks the equity in your home so you can be more financially secure in retirement.
Not risky, but not always the right fit
As I’ve already discussed, I don’t see a reverse mortgage as risky. However, that doesn’t mean it’s always the right fit. The following are some situations where a reverse mortgage may not make sense:
- You plan to move in the near future. There are no limitations on selling, but reverse mortgages are best for those planning to stay in their homes. Much of the benefit comes out over time, so it usually doesn’t make sense to keep a reverse mortgage just for a short time.
- You desire to pass the maximum equity possible to your heirs. Remember, the point of a reverse mortgage is to convert equity into cash. If you want to leave the most equity possible to your heirs, then it’s probably a poor fit.
- You live with young children and/or disabled relatives and want them to continue living in the home if you pass. The reverse mortgage becomes due when the last borrower has permanently left the home. If you have other people living in the home who can’t pay off or refinance the balance when you pass away, they will be forced to move out.
- You know you’ll need your equity in the future. If you know you’ll need your equity in the future to move into a nursing or senior-living facility, a reverse mortgage may not make sense. Remember, the purpose of a reverse mortgage is to convert equity into cash. This means that the reverse mortgage gradually reduces your equity position in your home over time.
What are the dangers of reverse mortgage financing?
So, what are the dangers of reverse mortgage financing? Is a reverse mortgage really as risky as many people say?
Unfortunately, there is a ton of misinformation floating around out there about the reverse mortgage. In my opinion, most people who view the reverse mortgage as risky do so because they don’t understand how it really works.
Again, a reverse mortgage is just a home loan. You always remain the owner of the home and you’re free to leave it your heirs. Your heirs will inherit any equity remaining in the home, whether they want to keep it or sell it.
No payments are required as long as at least one borrower or non-borrowing spouse lives in the home and pays the required property charges.
For the right candidate, a reverse mortgage is far from risky or dangerous. In fact, many seniors may be at greater financial risk without a reverse mortgage.
