What Are the Disadvantages of Reverse Mortgages?

A reverse mortgage allows homeowners to convert a portion of their home equity into cash without selling the property or making monthly mortgage payments. While this financial tool can offer flexibility for seniors, understanding its potential drawbacks is important for homeowners considering this option.

Loan Balance Growth

Unlike traditional mortgages where scheduled payments reduce the principal balance, a reverse mortgage balance increases. This growth occurs because interest, mortgage insurance premiums, and other fees are added to the outstanding loan balance. As these charges accrue, they compound, causing the loan balance to grow at an accelerating rate.

The continuous growth of the loan balance directly diminishes the homeowner’s equity. Over time, the increasing loan balance can consume a significant portion, or even all, of the home’s equity. This reduction in equity can concern homeowners who intend to leave their property as an inheritance. When the loan eventually becomes due, there may be little to no remaining equity for beneficiaries after the loan is repaid.

Associated Costs and Fees

Reverse mortgages involve various costs and fees that reduce the net proceeds available to the homeowner and add to the overall loan expense. One significant upfront charge is the origination fee, which compensates the lender for processing the loan application. For federally insured Home Equity Conversion Mortgages (HECMs), this fee is capped and can be up to $6,000.

Another substantial cost is the Mortgage Insurance Premium (MIP), which is mandatory for HECM loans. There is an upfront MIP paid at closing, typically 2% of the home’s appraised value. An annual MIP also accrues over time and is added to the loan balance. These premiums contribute to the growing loan balance.

Servicing fees, charged for managing the loan account, are also incurred monthly. These fees, along with other closing costs such as appraisal fees, title insurance, and recording fees, can range from 2% to 5% of the home’s value. While many of these costs can be financed into the loan, doing so reduces the amount of cash available to the homeowner and adds to the total debt.

Impact on Government Assistance Eligibility

Reverse mortgage proceeds, although generally not considered taxable income, can affect eligibility for certain needs-based government assistance programs. Programs like Medicaid and Supplemental Security Income (SSI) have strict asset limits. While loan proceeds are not treated as income, they can be counted as an asset if not spent.

If a homeowner receives a large lump sum from a reverse mortgage and keeps the funds in a bank account, these unspent funds can push their total assets above program-specific limits. For instance, the asset limit for an individual for SSI is typically $2,000, and Medicaid limits vary by state. Exceeding these thresholds can lead to a reduction or complete loss of benefits. Careful management and timely spending of reverse mortgage funds are necessary to avoid jeopardizing eligibility for these programs.

Conditions Requiring Loan Repayment

A reverse mortgage does not require monthly payments, but the full loan balance, including accrued interest and fees, becomes due and payable upon specific triggering events. The most common trigger is the death of the last surviving borrower. At this point, the heirs or estate are typically responsible for repaying the loan.

Other conditions that trigger repayment include the sale of the home or if the borrower permanently moves out of the property. A permanent move typically means the home is no longer the primary residence for 12 consecutive months. Borrowers must also continue to meet loan obligations, which include paying property taxes, homeowner’s insurance, and maintaining the home in good condition. Failure to adhere to these terms can cause the loan to become due and payable, potentially leading to foreclosure if the obligation is not met.