What are the dangers of reverse mortgage financing? Is a reverse mortgage risky? If so, what are the risks?
Questions like these come up from time to time and I always find them puzzling. I don’t see a reverse mortgage as risky. It can be a poor fit for some people, but calling it “risky” or “dangerous” is a stretch, in my opinion. A traditional mortgage 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 them. 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 potential risks, let me first cover some basics. If you’re already familiar with the basics of a reverse mortgage, 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 is living in the home and paying 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 simply pay off or refinance the balance. If they don’t want to keep the home, they can either sell it themselves or let the lender sell it. They’ll inherit the remaining equity once the home is sold and the reverse mortgage balance is paid off.
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?
Yes, you have to keep up with the required property charges, but you have to do that when you own a home anyway. If you fail to pay the 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.
Your requirement under the reverse mortgage is to just 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, no payments are required.
A financial safety net
The way I see it, the 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.
If your home is free and clear, the reverse mortgage can instead be structured like a tax-free retirement account that grows larger over time. This can serve 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. Though there is no limitation on selling and moving, the reverse mortgage is better suited for homeowners planning to stay in their homes long term.
- You desire to pass the maximum equity possible to your heirs. The reverse mortgage is designed to convert equity into cash. If your goals is to leave the most equity you can to your heirs, it’s obviously not a good fit for you.
- 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 die, 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.
As long as at least one borrower or non-borrowing spouse is living in the home and paying the required property charges, no mortgage payments are required.
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.