What Are the Negatives of a Reverse Mortgage?
Uncover the less talked about aspects of reverse mortgages. Understand their full implications for your home and financial future.
A reverse mortgage allows homeowners, typically those aged 62 or older, to convert a portion of their home equity into cash without needing to sell their property. This financial product provides funds as a lump sum, monthly payments, a line of credit, or a combination, and recipients generally do not make monthly mortgage payments. While offering a way to access housing wealth, a reverse mortgage carries specific financial considerations and responsibilities.
Understanding Accruing Costs
A reverse mortgage loan balance grows over time, primarily due to interest accrual. Unlike a traditional mortgage where payments reduce the principal, interest on a reverse mortgage is added to the outstanding loan balance each month. This compounding interest means interest is charged on the principal and accumulated interest, causing the debt to increase. Home Equity Conversion Mortgages (HECMs), the most common type, are non-recourse loans, meaning the borrower or their heirs will not owe more than the home’s value at the time of repayment, even if the loan balance exceeds it.
Upfront fees contribute to the initial loan balance, reducing the net proceeds available to the borrower. These costs typically include an origination fee, which for HECMs can be 2% of the first $200,000 of the home’s value and 1% of the amount over $200,000, capped at $6,000. Additionally, there is an upfront mortgage insurance premium (MIP) for HECMs, set at 2% of the appraised value or the maximum lending limit, whichever is less. Other closing costs, such as appraisal fees, title insurance, and escrow fees, are often financed into the loan.
Beyond initial charges, ongoing fees accrue on the loan balance. This includes an annual MIP, which for HECMs is 0.5% of the outstanding loan balance and is added monthly. Some reverse mortgages may also include monthly servicing fees, typically around $30 to $35, to manage the loan. These recurring costs, combined with compounding interest, mean the total amount owed steadily increases.
Implications for Home Equity and Inheritances
As the reverse mortgage loan balance increases due to accruing interest and fees, the homeowner’s equity diminishes. This reduction in equity means less of the home’s value will be retained by the homeowner or their estate. This erosion of equity impacts the potential inheritance for heirs.
When the reverse mortgage becomes due and payable, typically upon the last borrower moving out or passing away, the loan must be repaid. The home is often sold to satisfy the debt, with proceeds first going to the reverse mortgage lender. Any funds remaining after the loan is repaid are then distributed to the heirs.
A larger loan balance, resulting from years of interest and fee accumulation, means there may be less, or even no, remaining equity for heirs. While the non-recourse feature protects heirs from owing more than the home’s value, they may still face the decision of selling the property to repay the loan or finding alternative means to cover the debt if they wish to keep the home.
Circumstances Leading to Loan Due and Payable
A reverse mortgage becomes due and payable when specific conditions in the loan agreement are no longer met. One primary trigger is non-occupancy, meaning the home is no longer the principal residence of at least one borrower. If the last remaining borrower permanently moves out (e.g., to assisted living, with family, or sells the home), the loan becomes immediately repayable. Temporary absences, usually up to 12 consecutive months for medical care, are typically permitted, but longer periods can trigger the loan becoming due.
Failure to pay property taxes is another common reason a reverse mortgage can become due. Even though borrowers do not make monthly mortgage payments, they remain responsible for paying all property taxes on time. Lenders may conduct a financial assessment to ensure the borrower’s ability to cover these costs, sometimes setting aside loan proceeds. If property taxes fall into delinquency, it constitutes a default on the loan, potentially leading to the loan being called due.
Homeowners must maintain adequate homeowner’s insurance. This insurance protects the property against hazards like fire and natural disasters, safeguarding the lender’s collateral. A lapse in insurance coverage or failure to pay premiums can result in the loan becoming due and payable. The lender may purchase force-placed insurance at a higher cost, which is added to the loan balance, or initiate foreclosure proceedings.
Maintaining the property in good condition is a borrower responsibility. Lenders require the home to be kept in good repair to preserve its value, as it serves as collateral for the loan. Significant neglect or disrepair that affects the home’s structural integrity or market value can be considered a violation of the loan terms. If the property is not maintained, the lender may require repairs, and failure to comply within a specified timeframe (often 60 days) can lead to the loan becoming due.
Potential Effects on Public Assistance Eligibility
Receiving funds from a reverse mortgage can impact eligibility for certain public assistance programs, particularly those that are means-tested. Programs like Medicaid and Supplemental Security Income (SSI) have strict asset limits that determine eligibility. While reverse mortgage proceeds are generally considered loan advances rather than income, unspent funds can count as assets.
If a borrower receives a large lump sum payment and retains a significant portion in a bank account, these funds could push total assets above Medicaid or SSI limits. This can result in ineligibility, potentially disrupting access to essential healthcare or financial support. To avoid this, some financial advisors recommend spending down funds within the same month they are received to prevent them from being counted as assets in subsequent months.
Regular monthly disbursements, if not spent within the month, could accumulate and affect asset limits. A reverse mortgage generally does not affect eligibility for programs like Social Security or Medicare, as these are not typically means-tested. For individuals relying on or anticipating means-tested benefits, careful planning regarding reverse mortgage funds is important to avoid unintended consequences.