You’ve probably seen the reverse mortgage commercials with Henry Winkler and Tom Selleck. They make reverse mortgages sound pretty good, right? But are reverse mortgages as good as they say? There has to be some downsides, right? What are the pitfalls of reverse mortgages that you need to watch out for?
I’m an experienced industry veteran who has done hundreds of reverse mortgages over the years. I’ll cut through the hype and explain what you need to watch out for and what you shouldn’t worry about. Yes, there are some potential reverse mortgage pitfalls, but they’re not something that most people need to be concerned with.
Before we dig into potential pitfalls, let’s first cover what a reverse mortgage is and how it works. Many of the perceived pitfalls you may hear about are actually based on misunderstandings about how reverse mortgages work. Let’s first cover the basics, then we’ll cover what to watch out for.
What Is A Reverse Mortgage?
A reverse mortgage is a unique mortgage product that gives homeowners 62 and older access to home equity without a mortgage payment.
The most popular reverse mortgage in the United States is the home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). If somebody you know recently got a reverse mortgage, they likely got a HECM.
The HECM program was created and signed into law by President Ronald Reagan as part of the Housing and Community Development Act of 1987. The Federal Housing Administration (FHA) insures and regulates the HECM under the authority of the Department of Housing and Urban Development (HUD).
Over 50,000 seniors get HECMs every year in America today. That number will likely grow as more seniors learn about the program.
How Does It Work?
First of all, a HECM is simply a home loan. It’s a unique home loan that unlocks your home equity so you can use it to enhance your retirement lifestyle and financial security.
You always remain the title owner of your home. You can leave your home to your heirs and they can either choose to keep it or sell it. If your heirs wish to keep the home, they can pay off or refinance the reverse mortgage balance. If your heirs don’t want the home and don’t want to mess with selling it, they can let the lender sell it. Once the lender sells the house, the loan balance is paid off, and any remaining equity goes into your estate.
The HECM is a non-recourse loan; the most that will have to be repaid is the value of your home. FHA will cover any shortage if your home isn’t worth enough to pay off the entire loan balance.
The HECM is highly customizable; you can tailor it to your individual financial goals and needs. You can take the proceeds as a lump sum, line of credit, term/tenure income, or a combination of these options.
You can also use a reverse mortgage to finance a home purchase with no mortgage payment.
Now that we’ve covered the basics, let’s dig into some possible reverse mortgage pitfalls.
Not as Risky as Some People Think
Honestly, 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. As I’ll cover shortly, many of the perceived reverse mortgage pitfalls are more about suitability than actual problems with the product.
Again, your end of the bargain is basically this:
- Live in the home
- Pay the property taxes
- Pay the homeowner’s insurance
- Pay your HOA dues (if applicable)
- Maintain your home like you normally would
Again, no repayment is requirement as long as you remain in good standing. There’s no time limit on that, either. For as long as you do these things, no payment or payback is required.
And again, 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.
The reverse mortgage is actually a very safe product. Any pitfalls are usually more about suitability than actual problems with the reverse mortgage. In other words, if the reverse mortgage has pitfalls, it’s probably because it’s not the right solution for you – not because it’s a bad product.
Potential Reverse Mortgage Pitfalls
So, what are some possible pitfalls of reverse mortgage financing? What are some situations where a reverse mortgage probably isn’t a good idea? Based on my experience, here are some situations where a reverse mortgage may not make sense:
- You want to leave the most equity possible to your heirs. The 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. If you want to leave the most equity possible to your heirs, then a reverse mortgage obviously doesn’t make sense. This is not a pitfall of reverse mortgages, in my opinion, it’s just a question of goals and suitability.
- Marrying after your reverse mortgage is complete. If you marry after your reverse mortgage is complete, your new spouse will not automatically “inherit” the reverse mortgage protections. If something happens to you, your spouse will have to pay off or refinance the reverse mortgage balance or potentially lose the home. If you marry after getting a reverse mortgage, you may consider taking out a life insurance policy to protect against this potential reverse mortgage pitfall.
- You’ll need your home equity in the future. If you need to preserve your home equity for the future (because you plan to move, perhaps), then you probably want to avoid a reverse mortgage. Again, the reverse mortgage converts home equity into cash. This means the balance will increase and your equity will decrease over time.
- 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 want to consider taking out a life insurance policy to repay the HECM balance after you pass away.
- Leaving your younger spouse off the reverse mortgage to qualify for more money. I’ve run across applicants who want to leave their 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 was always a dumb idea, in my opinion. Remember, at least one borrower or non-borrowing spouse has to live in the home, maintain it, and pay the property charges or the reverse mortgage becomes due and payable. If the younger spouse is not on the reverse mortgage, he or she is not a borrower. That means he or she will have to settle up the reverse mortgage if the older spouse passes away. If that’s not possible, the surviving spouse risks losing the home.
- 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 because it could trigger a maturity event.
It’s More About Suitability Than Pitfalls
Hopefully what I’ve covered here puts your mind at ease about reverse mortgages. As we’ve covered, it’s tough to get into trouble with a reverse mortgage as long it’s a good fit and you remain in good standing. Yes, there are some potential reverse mortgage pitfalls, but they’re usually more about suitability than problems with the reverse mortgage.