5 Downsides of a Reverse Mortgage
A Home Equity Conversion Reverse Mortgage (HECM), more commonly known as a reverse mortgage, is often used as a means of income for retirees. For those age 62 or older, these loans can provide guaranteed income during retirement (See also: 6 Ways to Guarantee Income in Retirement).
Though there are some similarities, reverse mortgages are not to be confused with home equity loans. Here, borrowers have to meet a minimum age restriction, hold the deed to their home, or have a relatively low balance that can be paid-off with a new loan. The home is then used as collateral for a new mortgage loan, up to $625,500 (or the lesser of the appraised value). But, instead of making monthly payments to the lender, the lender makes monthly payments to you, drawing on your home equity. It's a bit like purchasing an annuity using your home's value.
Sounds good, right? Not so fast. Reverse mortgages come with some significant drawbacks for certain borrowers. Consider these negatives before taking out a reverse mortgage.
Downsides of Reverse Mortgages
On the surface, reverse mortgages probably sound like a pretty decent idea since the bank pays you, right? Well, in a report published by the Consumer Financial Protection Bureau (CFPB), between December 2011 to December 2014, the agency processed approximately 1,200 consumer complaints arising from reverse mortgages. Borrowers reported "confusion and frustration over the terms" and "problems with loans servicing" as culprits causing them to face foreclosure.
1. Unable to Refinance and Misleading Terms
It appears many borrowers enter into loan agreements without fully understanding the terms of the loan. Among the complaints received by the CFPB from borrowers and their family members was not being able to renegotiate. Borrowers felt they were paying a high interest rate and were being overcharged. Others said they did not realize their adjustable interest rate would increase so quickly.
2. High Upfront Costs and Interest Rates
In comparison to the costs for obtaining a regular home loan, reverse mortgage costs are higher due to the way loans are structured. They also have higher interest charges. Interest rates on reverse mortgages tend to be 1.5% higher than regular home loans. Final costs include closing costs, lender fees, mortgage insurance premiums, and finance charges.
3. A Burden on Heirs
Home equity loans aren't a great choice if you intend on leaving your home as part of an inheritance. That's because these loans not only draw on the value of your home equity, but they're also due immediately upon your death. If your plan is to leave the property to your heirs, they will have the option of paying the loan in full or paying 95% of the balance (if they wish for it to remain in the family). If they're unable to settle the debt with their own funds, the asset must be sold in order to repay the lender. Once the debt is settled, any remaining proceeds will go to the estate.
But reverse mortgages are also due whenever you decide to sell the home — so if your retirement plans involve living anywhere other than your current residence, you'll have to fork over the balance of the loan as soon as you sell.
4. Facing Foreclosure When an Older Spouse Dies
When determining a borrower's eligibility for a reverse mortgage, age is crucial for two reasons:
- The borrower must be 62 or older, and
- The older a borrower is, the greater the loan amount he or she qualifies for.
For this reason, many couples agree to only include the name of the older spouse on closing documents, not aware that the surviving spouse could face foreclosure if the other dies. According to CFPB, consumers reported that loan originators falsely assured them they would be able to add the younger spouse to the loan at a future date. Make sure you read the fine print and clarify this concern before signing on the dotted line.
5. Difficulty Qualifying for Other Loan Types
Borrowers cannot refinance a reverse mortgage. Reverse mortgages may also have a negative impact on a borrower's ability to qualify for other types of loans. Over time, the accrued interest on reverse mortgages drain any remaining equity in your home. Worse, some homeowners complained that they were unaware of the terms of these types of loans. Before entering into an agreement, seek the counsel of a trusted third-party reverse mortgage professional. Hud.gov offers a directory of HECM counseling agencies, however turning to members of your community to find a referral is recommended.
Additionally, the CFPB report mentioned consumer concerns of encountering difficulty when attempting to repay loans. This included lenders failing to keep accurate records, and obstacles when attempting to prevent foreclosure — such as slow response times (critical during foreclosure), unresponsiveness, and receiving erroneous information or instructions.
While a reverse mortgage can be a good source of cash flow during retirement, it nonetheless requires careful consideration for the critical reasons listed above. If you're still interested in a reverse mortgage, do your homework, and understand the resources at your disposal. (For example, on March 2, 2015, The Federal Housing Authority implemented new policies to its HECM Financial Assessment to address consumer complaints.)
Have you considered a reverse mortgage? Why or why not?
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