What Are the Downsides of a Reverse Mortgage?

A reverse mortgage allows older homeowners to access a portion of their home equity as cash, providing financial flexibility without requiring monthly mortgage payments. While beneficial, this product also has potential downsides borrowers should understand. This article explores these negative aspects for those considering a reverse mortgage.

Costs and Fees

Reverse mortgages involve various costs and fees that impact the net proceeds available to the borrower and increase the overall loan balance. Lenders charge an origination fee to cover loan processing costs. For federally insured Home Equity Conversion Mortgages (HECMs), this fee is generally capped at $6,000.

Beyond the origination fee, borrowers face third-party closing costs similar to those found in traditional mortgages. These may include appraisal fees, title insurance, escrow fees, recording fees, credit report fees, and document preparation fees. These costs can vary based on location and the specific services required.

Ongoing costs also contribute to the growing loan balance. Mortgage insurance premiums (MIPs) are a notable expense for HECMs, consisting of both an upfront premium and annual premiums. The upfront MIP is 2% of the lesser of the home’s value or the maximum claim amount, paid at closing. Additionally, an annual MIP of 0.5% of the outstanding loan balance is charged throughout the life of the loan.

Some lenders may also charge a monthly servicing fee, up to $35. This fee covers administrative costs like disbursing payments and monitoring loan compliance. These fees and costs are typically added to the loan balance, reducing the cash available to the borrower and increasing the total debt over time.

Impact on Home Equity and Estate

A significant aspect of a reverse mortgage is its effect on the home’s equity and the inheritance left to heirs. Interest accrues on the outstanding loan balance, which includes the principal, previously accrued interest, and all fees. This interest is added to the loan balance monthly, creating a compounding effect that causes the total debt to grow over time.

Unlike traditional mortgages, reverse mortgages do not require monthly payments from the borrower, meaning the loan balance continuously increases unless voluntary payments are made. This growing debt reduces the amount of equity remaining in the home. Over the loan’s term, especially if the borrower lives for an extended period, the accumulating balance can consume a substantial portion of the home’s value.

When the last borrower permanently leaves the home, typically due to death, the reverse mortgage becomes due and payable. At this point, the heirs have several options: they can repay the loan, often by refinancing it, or sell the home to satisfy the debt. An important protection for heirs is the non-recourse feature, which is common in federally insured HECMs. This feature ensures that the amount owed can never exceed the home’s appraised value or 95% of its appraised value, whichever is less, at the time the loan becomes due, protecting heirs from personal liability for any shortfall. However, even with this protection, there may be little to no equity remaining for heirs, or they may need to take action to either repay the loan or sell the property quickly.

Conditions Leading to Loan Default

Even though reverse mortgages do not require monthly mortgage payments, borrowers must still adhere to specific obligations to avoid defaulting on the loan, which could lead to foreclosure. Borrowers are responsible for continuing to pay property taxes and homeowner’s insurance premiums. Failing to make these payments can result in the loan becoming due and payable, potentially leading to foreclosure.

Another condition for maintaining the loan is keeping the home in good repair. Lenders have an interest in preserving the property’s value, and significant disrepair can be considered a default. The home must also remain the borrower’s primary residence. If the borrower moves out permanently or is absent for an extended period, the loan can become due and payable.

Failure to meet any of these requirements can trigger the loan’s repayment clause, even without missing a traditional mortgage payment. While lenders may offer options like repayment plans or “at-risk extensions” in certain circumstances, the ultimate consequence of unaddressed default is the potential loss of the home.

Considerations for Non-Borrowing Spouses

Reverse mortgages present unique considerations for spouses not listed as borrowers on the loan. Protections exist for “eligible non-borrowing spouses” (ENBS) in HECMs. To qualify as an ENBS, the spouse must meet specific criteria:
Be married to the borrower at the time of loan closing.
Have lived in the home as their principal residence at that time.
Continue to reside there after the borrowing spouse’s death or permanent departure.
Be identified in the loan documents.

These protections allow an ENBS to remain in the home after the borrowing spouse’s death, provided they continue to meet the loan obligations, such as paying property taxes, insurance, and maintaining the home. However, the ENBS cannot access any remaining loan funds or a line of credit after the borrowing spouse’s death.

For spouses who do not meet the ENBS criteria, often called “ineligible non-borrowing spouses,” the implications are more severe. If the last borrowing spouse dies or permanently leaves the home, the loan becomes immediately due and payable. This means the ineligible spouse may be forced to repay the entire loan balance or sell the home, potentially facing displacement if they cannot satisfy the debt. Couples should fully understand the implications for both borrowing and non-borrowing spouses before proceeding with a reverse mortgage.