January 26, 2018 by HECM Pro
There’s no question a HECM reverse mortgage is a fantastic financial tool that offers increased financial stability and freedom in retirement. However, it’s not the perfect solution for everybody; there are some situations where you may want to avoid a reverse mortgage.
Before we dig into the reasons not to get a reverse mortgage, let’s first go over what a HECM reverse mortgage actually is. There’s a lot of misinformation floating around out there, so I want to cover the basics before identifying some situations where a reverse mortgage may not be a good fit.
What the Heck is a HECM?
The most common reverse mortgage product in the United States today is the FHA-insured home equity conversion mortgage, or HECM (often pronounced heck-um by industry insiders). If somebody you know recently got a reverse mortgage, it’s a good bet it was a HECM.
The HECM reverse mortgage is designed to give homeowners 62 or older the ability to convert a large portion of their home’s value into tax-free cash without taking on a mortgage payment or giving up ownership of the home. As long as you live in the home and stay current with property taxes and homeowners insurance, no monthly payments are required and the loan balance does not have to be repaid.
You always retain title ownership of your home, which means you’re free to will it to your heirs. If your heirs wish to keep the home, they need to pay off or refinance the reverse mortgage balance. If they’d rather not keep the home, they can sell it on their own or let the lender sell it. Any equity left in the home after the reverse mortgage is repaid will go to your heirs.
The HECM reverse mortgage is very versatile and can be tailored to your financial needs and goals. Proceeds can be received in the form of a lump sum, line of credit, term or tenure payments, or some combination of all of these.
The HECM is a non-recourse loan, which means you’ll never leave a big financial mess to your heirs. If the home isn’t worth enough to settle the entire balance, the shortage is covered by the FHA insurance fund.
6 Reasons to Avoid a Reverse Mortgage
Now that we’ve covered the basics, what are the reasons you may want to avoid a reverse mortgage? Having talked to and worked with thousands of clients over the years, I can think of a few scenarios where a reverse mortgage probably doesn’t make sense.
1) You wish the leave the maximum home equity you can to your heirs. The purpose of the reverse mortgage is to convert home equity into cash, which means your loan balance increases and your home equity decreases over time (assuming property values don’t rise rapidly). If your goal is maximize the equity you leave to your heirs, you’ll probably want to avoid a reverse mortgage.
2) You plan to move soon. The HECM reverse mortgage doesn’t prevent you from selling and moving, but it’s better suited for homeowners who don’t plan to anytime soon. Qualifying involves some effort on your part and some closing costs typically have to be paid as well, so a reverse mortgage often doesn’t make sense as a short-term solution.
If you know you’re going to be selling your current home and buying a new one within the next year or two, it’s probably better to avoid a reverse mortgage for now. You can always get a reverse mortgage once you’re settled into your new home.
3) You need a relatively small amount of cash and plan to repay it quickly. If you need a relatively small amount of money and plan to pay it back quickly, a reverse mortgage could be overkill. A better solution might be a home equity line of credit (HELOC), which can be faster, cheaper, and easier to obtain (as long as you’re well-qualified).
If you do opt for a HELOC, be sure to repay the money before the end of the draw period to avoid potential payment headaches. HELOC payments can often increase substantially at the end of the draw period.
4) You have a disabled relative living with you. If you have a son or daughter or other relative living with you who can’t take care of themselves, a reverse mortgage could force them out of the home if something happens to you. If your intent is for them to continue living in the home after all reverse mortgage borrowers have passed, you may want to avoid a reverse mortgage unless you know they can repay (such as with life insurance proceeds) or refinance the balance. Again, the reverse mortgage has to be repaid in full once the last borrower permanently leaves the home.
5) Your home is in very poor shape. A HECM reverse mortgage likely isn’t a workable solution if your home is in poor shape. The Federal Housing Administration (FHA) governs the program and has certain minimum standards that your home needs to meet for it to even qualify. If your home is in poor shape, a hard money or rehab loan might be a better solution. You’ll have a monthly payment, but you could potentially refinance the borrowed money into a reverse mortgage later (as long as you still have an adequate equity position in the home).
For more information about what an FHA appraiser looks for, feel free to check out the relevant portion of the FHA lending guide here.
6) You plan to get married in the near future. A new spouse is not automatically “grandfathered” into the protections and benefits of an existing reverse mortgage. If only your name is on the reverse mortgage, your spouse will have to settle up the reverse mortgage balance or move out of the home if something happens to you. If you know you’ll be getting married soon, it’s probably better to avoid a reverse mortgage for now and get it done once you’re married.
When a Reverse Mortgage Makes Sense
If you’re over 62, a homeowner, and none of the above items apply to you, a reverse mortgage could be a great option. If you owe less than half the home’s value (or nothing at all), a HECM reverse mortgage could substantially enhance your retirement:
Many reverse mortgage borrowers use the proceeds to:
- Eliminate existing mortgage payments
- Eliminate other debts, such as credit cards and auto loans
- Finance home improvements
- Supplement retirement income
- Pay off medical bills
- Increase liquid retirement assets
- Set up a rainy day or emergency fund
- Take a vacation
Again, you always remain the owner of the home and are free to leave it to your heirs. As long as at least one borrower is living in the home and paying the required property charges, no payment or payback is required. It’s only after the last borrower permanently leaves the home that the reverse mortgage has to be repaid.
A reverse mortgage isn’t a perfect solution for necessarily everybody, but it can be a fantastic option for the right candidate.