Reverse mortgages have long been marketed to older people who are “house rich and cash poor.” This kind of loan lets you tap into your home equity and get a check each month while remaining in your house. But what sounds like a great idea, in theory, is often terrible in reality.
Here’s What You Need To Know About Reverse Mortgages
You often see older celebrities pushing reverse mortgages in TV commercials. The ads are all pretty similar: spokespeople telling you how great a financial move a reverse mortgage can be. But money expert Clark Howard disagrees.
“Reverse mortgages have been a source of calls into our show for at least a couple decades now,” Clark says. “The market has been dirty forever. You have to be so very careful. I know the ads that appear with the older actors who have high likeability ratings, but let me tell you, there are a lot of snakes in the grass.”
Table of Contents:
- What Is a Reverse Mortgage?
- How Does a Reverse Mortgage Work?
- How Much Does a Reverse Mortgage Cost?
- What Is the Downside to a Reverse Mortgage?
- Can I Cancel a Reverse Mortgage?
- What Are the Alternatives to a Reverse Mortgage?
What Is a Reverse Mortgage?
A reverse mortgage is a loan where a lender pays you (instead of the other way around), adding to the interest you owe and drawing down the equity in your home over time.
It’s called a reverse mortgage simply because it’s the exact opposite of having a loan in which you pay a lender every month and build equity.
Reverse mortgages target people who own their homes free and clear (or close to it) but need money to live. Traditionally, this has been senior citizens who aren’t getting enough from Social Security to meet their monthly bills.
How Does a Reverse Mortgage Work?
There are three common types of reverse mortgages, according to the Federal Trade Commission (FTC).
- Single-purpose reverse mortgages
- Proprietary reverse mortgages
- Home Equity Conversion Mortgages (HECMs)
A single-purpose reverse mortgage lets you use the funds you get for one purpose and one purpose only — be it home repairs, improvements or property taxes — which is specified in the loan. These loans are typically offered by state and local government agencies as well as some nonprofit organizations. They’re not available in every state, but most low- and middle-class homeowners are able to qualify for them.
Proprietary reverse mortgages are the same except they’re available only through private lenders. They’re usually for people who own higher-value homes.
HECMs are federally-insured reverse mortgages that don’t usually have any income requirement. They’re backed by the U. S. Department of Housing and Urban Development.
No matter which kind of reverse mortgage you choose, you either get a check every month or a one-time lump sum from the lender.
But remember, this is a loan with your house as collateral.
You usually don’t have to pay the money back as long as you’re living in your home. However, if you die, sell your home or move out, you or your estate must repay the lender. That usually means selling the home.
And keep this in mind: While you’re in the house, you’ll still be responsible for the property taxes, insurance, utilities, maintenance and everything else that goes along with owning the home.
Methods of Payment for Reverse Mortgages
Typically, you can get paid in six ways:
- Lump sum
- Monthly payment (annuity)
- Line of credit
- Term payments (example: 10 years)
- Monthly payments plus a line of credit
- Term payments plus a line of credit
Requirements for Receiving and Maintaining a Reverse Mortgage
- You have to be at least 62 years old.
- You must have at least 50% equity in your home.
- The home must be your primary residence.
- Your home, townhouse or condo must have been built on or after June 15, 1976.
- You must keep your property taxes and homeowner’s insurance up to date for the life of the reverse mortgage.
Your entire balance becomes due when you die, move out or sell your home. However, the loan amount can’t exceed your home’s value.
How Much Does a Reverse Mortgage Cost?
“If you want to do this, you need to shop, shop, shop. Because not all lenders are created equal,” Clark says. “The fees vary tremendously from one to another.”
LendingTree says you should expect to pay a lender fee of whichever is greater: $2,500 or 2% of the first $200,000 of your home’s appraised value. If you have an appraised value greater than that, expect to pay an additional 1% of your home’s value above $200,000.
In order to secure a reverse home mortgage, you’re required to undergo independent third-party financial counseling. According to Investopedia, the counseling sessions run about 90 minutes and cost about $125.
Although you won’t have to pay anything on your reverse mortgage month to month, be aware there are other significant costs up front (although they’re limited by regulations). Other fees include:
- Origination fee for the loan
- Mortgage insurance via an up-front premium
- Closing costs
- Mortgage insurance premiums (MIPs)
- Interest (rolled into your mortgage)
What Are the Downsides to a Reverse Mortgage?
Reverse mortgages remain a popular lure for cash-strapped seniors, but what’s good in theory is often terrible in execution.
First off, they’re packed with fees as noted earlier.
Meanwhile, if you take the lump-sum cash-out option, that can put you in the crosshairs of sleazy insurance salespeople who’ll push a series of annuities on unsuspecting seniors.
“This is just an absolute, horrific abuse of trust and of that senior citizen,” Clark says.
You risk home foreclosure with a reverse mortgage, as your home serves as collateral for the loan. You also can’t deduct interest payments from your taxes via your mortgage until you pay off the loan.
Finally, a reverse mortgage, by design, takes part of your home equity and converts it into payments for you. As you use up the equity in your home in this way, there’s less to leave to your heirs. You should be aware of that before you decide.
Can I Cancel a Reverse Mortgage?
You can cancel a reverse mortgage thanks to a cooling-off period set by law. The FTC says you have three business days to cancel after you sign the contract.
This process, known as “rescission,” is best accomplished by putting in a notice to cancel into a letter. And then sending that letter to the lender by certified mail, return receipt requested.
Your letter should document any monies the lender got from you and when. The FTC advises you to keep copies of all your correspondence including any enclosures. Upon receipt of the letter, the lender has 20 days to refund anything you paid as a finance charge to get the loan going.
What Are the Alternatives to a Reverse Mortgage?
As you can probably tell by now, Clark Howard isn’t keen on reverse mortgages.
“If you’re talking about a family with younger members of means, it is generally better to have them financially help out an aging relative or relatives than to have a broker or salesperson take advantage of the senior with a reverse mortgage,” Clark says.
So it’s wise to consider the alternatives which include:
- Selling your home and downsizing
- Refinancing your home
- Taking out a HELOC or home equity loan
- Selling to family
The first one is obvious and really comes down to a personal choice about whether you’re willing to move or whether you would prefer to age in place.
Second, if you’re looking to refinance, we have a guide to walk you through the process here.
Third, check out our article on home equity loans and home equity lines of credit (HELOCs), here.
Finally, there’s a rarely used alternative when aging parents have adult children who are of means. The grown children can actually lend their parents the money, like a bank reverse mortgage, but the equity flows to the kids — not to the bank.
National Family Mortgage is the only organization we know of that will draw up and manage one of these so-called “caregiver mortgages” on your family’s behalf.
Reverse mortgages are advertised heavily on TV and elsewhere with the promise that they can bring a lot of cash back into your life. But you’ve got to consider carefully if one is right for you.
“If you’re short of cash in retirement, a reverse mortgage may be an option for you — but it’s a last option,” Clark says. “The time to use it is when you’ve come up with every other way to pay for monthly expenses and you’re still short of money.”
Meanwhile, if you have additional questions about reverse mortgages, reach out to our Consumer Action Center.