A reverse mortgage allows homeowners age 62 or older to tap equity without making a mortgage payment on the amount they borrow. However, the most popular reverse mortgage program, the Home Equity Conversion Mortgage (HECM), comes with some drawbacks worth considering. Understanding reverse mortgage pitfalls and how to avoid them can help you decide if a HECM loan is the best option for your financial needs.
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1. Your loan balance grows each month
With a reverse mortgage, your loan balance increases each month as your lender makes payments to you. It works in the “reverse” of a regular, forward mortgage, which shrinks as you make monthly payments to your lender. That means the ongoing fees associated with HECM loans, such as the annual mortgage insurance premium (MIP) will increase as well.
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2. Your equity shrinks each month
Home equity is the difference between your home’s value and your loan balance, and because your loan balance increases each month, your home equity drops. This may be offset by home price appreciation in your neighborhood, but it could also have an impact on your ability to sell the home in the future if values go down. Keep an eye on home sales in your area or call a real estate agent to prepare a comparative market analysis that shows the price trends of recent nearby home sales.
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3. You’ll pay high closing costs and ongoing fees
HECM loans are insured by the Federal Housing Administration (FHA): This means you’ll pay FHA mortgage insurance premiums to protect lenders against losses if you default, as well as closing costs that are typically higher than those of a regular FHA loan. The table below highlights some of the differences between a HECM and regular FHA loan.
|Closing costs||Reverse mortgage||Regular FHA mortgage|
|HECM counseling||$125 or more||Not required|
|Origination fees||Up to $6,000||Varies based on your loan amount|
|Upfront mortgage insurance premium||2% of the loan amount||1.75% of the loan amount|
|Annual MIP||0.5% of your loan amount||0.45% to 1.05% depending on your down payment and loan term|
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4. Your interest rate is typically adjustable
Unless you receive your reverse mortgage funds in one lump sum, you’ll have an adjustable interest rate on your loan balance. As interest rates rise, your loan balance will grow faster, leaving you with less home equity as time goes on.
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5. Your heirs will inherit a home with less equity
Because a reverse mortgage balance grows over time, your heirs will receive less equity when you move or upon your death. Although they have limited responsibility for the remaining balance after you die, if they can’t repay the loan, they won’t be able to keep the home.
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6. You must live in your home most of the time
Reverse mortgages are meant to give you more ways to use your home equity and meet changing financial needs as you age in place However, lenders expect that you will live in your home most of the time. If you need to move into an assisted living facility, your lender could require you to pay off the balance or they could foreclose on the loan.
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7. Your government benefits could be reduced
Check with a financial planner if you receive Supplemental Security Income (SSI) or Medicaid. If you choose to receive reverse mortgage funds as monthly income, your benefits could be affected.
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8. You could outlive your reverse mortgage
With some homeowners living into their 90s, it’s possible that you’ll outlive your reverse mortgage. This could result in a reverse mortgage balance that’s higher than your home’s value. One built-in protection allows you to sell the home at 95% of its value, and let the mortgage insurance pay the difference.
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9. You could be part of a reverse mortgage scam
As seniors age, they sometimes become more socially isolated, making them high-risk targets for reverse mortgage scams. Look for tactics that may be a sign that you or a loved one are being taken advantage of by a fraud scheme.
Below are some examples:
- Investment schemes. A sales representative tries to persuade you to invest reverse mortgage funds into an insurance product or annuity promising high returns.
- House-flipping. Real estate agents or loan officers use the proceeds of a HECM to buy and sell a property for a quick profit.
- Bogus home improvement. A handyman shows up at your door recommending repairs to your home, and suggests you finance them with a reverse mortgage.
- Mortgage payment relief. A company offers mortgage payment relief and charges an upfront fee, advertises a “100% money-back guarantee” or emails you a message that you can “stop foreclosure now.”
- Pushy sales tactics. Legitimate reverse mortgage salespeople won’t pressure you into getting a reverse mortgage, because they know you’ll have to meet with a housing counselor approved by the U.S. Department of Housing and Urban Development (HUD) before completing your application.
- Inheritance schemes. According to the National Center on Elder Abuse, family members are most likely to abuse elderly relatives. File a complaint with the Federal Trade Commission if you suspect reverse mortgage fraud, or with the adult protective services agency in your state if you believe you or a senior is a victim of elder abuse.
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10. You have to prove you can pay ongoing costs
Although you don’t have a mortgage payment, you still need to prove you can pay for ongoing costs like property taxes, homeowners insurance and home maintenance. If you’re concerned that you may have difficulty making these payments, discuss having funds set aside each month to pay them, similar to how an escrow account works on a regular mortgage.
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How to avoid reverse mortgage pitfalls
Choose a reverse mortgage line of credit option and only use what you need.
Interest and mortgage insurance are charged based on your reverse mortgage loan balance: The higher the balance, the higher the charges and the faster your loan balance grows. The line of credit option is similar to how a home equity line of credit (HELOC) works: You use the funds as needed, and interest and mortgage insurance are only charged on the balance drawn.
Set aside money in your budget for property taxes, insurance and maintenance.
Set up an asset account to have one month’s worth of property taxes deducted monthly instead of paying them with your reverse mortgage funds. It’s also a good idea to budget 1% of your home’s value to use toward home maintenance and repairs.
Wait until you’re older to take out a reverse mortgage.
The older you are, the higher your loan limit will be. And don’t forget that if you’re married, the reverse mortgage loan limit is based on the age of the youngest spouse.
Ask a lot of questions when you meet your HUD reverse mortgage counselor.
Don’t be afraid to ask as many questions about your reverse mortgage as needed. Even though you aren’t making a payment, you are taking out a loan that will get larger with time — this could have financial consequences for you or your heirs down the road.
Seek help immediately if you think you’re being scammed.
Contact your local FBI office immediately if you think you or an elderly relative are being scammed by a reverse mortgage fraudster. You can also contact HUD’s inspector general online or your state attorney general’s office.
Use a home equity alternative to create a rainy day hedge.
If you’re comfortable with your monthly retirement income, consider a home equity loan, HELOC or a cash-out refinance to give you a cash cushion.
- A home equity loan is a lump sum second mortgage with terms typically ranging from five to 15 years and fixed monthly payments.
- A home equity line of credit is like a credit card that you can use as needed for a set time (usually 10 years), known as a draw period. You only make payments on your HELOC balance, plus interest charges, and can repay and reuse the balance as needed during the draw period.
- A cash-out refinance is a new mortgage that allows you to borrow more than you currently owe on your home and pocket the difference in cash. You can borrow up to 80% of your home’s value with most cash-out refinance programs. However, military borrowers can tap up to 90% of their home’s value with a cash-out refinance backed by the U.S. Department of Veterans Affairs (VA).
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