Companies spend a lot of money making reverse mortgages sound appealing, but the truth is that getting a reverse mortgage isn’t always the best idea.
For years reverse mortgages have been championed as a great way for you to fund your retirement (if you are of retirement age) by borrowing against one of your biggest assets: your home.
But unfortunately, reverse mortgages come with a lot of drawbacks that can really impact your budget and put you in a worse financial position.
If you have considered taking out a new reverse mortgage, here are 5 reasons why taking out a reverse mortgage may be a bad idea.
Contrary to popular belief, financing isn’t free. Much like you would pay closing costs and fees to obtain a traditional mortgage, reverse mortgages come with a variety of costs. These costs can make reverse mortgages expensive in both the short and long term.
To start, most lenders charge origination fees when you decide to take out a new reverse mortgage. The actual costs will depend on the value of your home but is usually a percentage of what your home is worth.
For a typical FHA insured home equity conversion mortgage (HECM), a typical origination fee can add up to 2% of the first $200,000 your home is worth or $2,500, whichever is less1. Anything over the first $200,00 will be an additional 1%1.
While these fees can vary for proprietary reverse mortgage products, they still add up. If you do go with an HECM loan, there are also upfront mortgage insurance premiums to consider.
Other factors related to cost that you should consider is that most reverse mortgages have a variable rate1. This means that the amount of interest added to your balance each month can vary over the entire loan term.
Problems After Probate
Another downside to using a reverse mortgage is how it will impact your estate when you pass away. Reverse mortgage can be especially problematic if you happen to die unexpectedly.
If you choose to have someone live with you, maybe a close friend or other relative, and you die unexpectedly, those individuals may no longer be permitted to occupy the home if they are not on the loan.
But your death could have even further implications for any heirs you leave behind. Since your reverse mortgage encumbers the home, the heirs may have to go through the process of selling it in order to pay off the outstanding debt.
The other option is that if your heirs want to retain the property, they must come up with the means to pay off the debt themselves or refinance it into a traditional mortgage. This can be quite a hurdle, especially if your heirs don’t have enough funds of their own or cannot qualify for a new mortgage.
Repairs, Insurance, and Cost of Living
Just because you open a new reverse mortgage doesn’t alleviate you from having to maintain your home. In fact, part of what you agree to will involve keeping up with maintenance and paying your real estate taxes and insurance.
Most people forget to factor these costs into their monthly budget when they take out a new loan. Over time, these costs can add up and really eat into what you get from your reverse mortgage. If you become delinquent on these expenses, you could default on your loan and risk going into foreclosure2.
Another item to consider is cost of living. A lot of times reverse mortgages don’t adequately keep up with the rising cost of living. The Bureau of Labor and Statistics noted that from 2018 to 2019 the cost of living on general household staples, including food and housing, increased by 2.3%3.
Relocating is Restricted
Make sure you love where you are living before you commit to a reverse mortgage. That’s because most reverse mortgages require that you occupy your home as a primary residence for most of the year.
When you move, you are also required to pay off the balance of your reverse mortgage. If you know you want to relocate in the near future, it may cost you more to get a reverse mortgage and pay all the costs just to pay it off.
If you are also a homeowner with health concerns, a reverse mortgage may not be a great solution. In general, you need to be healthy enough to live in your home and maintain it.
If your health declines to a point where you have to move into assisted living or another long-term care facility permanently, the debt would need to paid off.
Impact Other Retirement Benefits
Reverse mortgages can also have tax consequences and impact your eligibility to receive other retirement benefits.
While the federal government may not consider the money you receive from a reverse mortgage as taxable income, you also cannot deduct any interest from your reverse mortgage on your annual tax return until the loan is paid in full1.
You also may not qualify for other government-sponsored programs such as social security income (SSI) or Medicaid2.
While a reverse mortgage may affect certain homeowners differently, it’s important to discuss these implications with a financial advisor or tax professional.
1 Egan, J. (2020, June 23). What Is the Downside of a Reverse Mortgage? Retrieved April 29, 2021, from https://www.experian.com/blogs/ask-experian/what-is-the-downside-to-a-reverse-mortgage/
2 Bond, C. (2021, March 31). 5 Reverse Mortgage Pros And Cons. Retrieved April 29, 2021, from https://www.forbes.com/advisor/mortgages/reverse-mortgage-pros-cons/
3 Bureau of Labor and Statistics. (2020, January 16). Consumer Price Index: 2019 in review. Retrieved April 29, 2021, from https://www.bls.gov/opub/ted/2020/consumer-price-index-2019-in-review.htm