What Is the Downside of a Reverse Mortgage?

A reverse mortgage allows homeowners, typically aged 62 and older, to convert home equity into cash without selling their property or making monthly mortgage payments. While this offers financial flexibility, it comes with several important considerations. This article explores the potential drawbacks of reverse mortgages, impacting a homeowner’s financial well-being and future plans.

Accruing Loan Balance and Associated Costs

A reverse mortgage loan balance grows over time, unlike a traditional mortgage. This happens because interest and various fees are added to the outstanding balance monthly. These charges compound, meaning interest is charged on the growing principal, plus accumulated interest and fees. The amount owed to the lender steadily increases throughout the loan’s term.

Borrowers incur several costs and fees associated with obtaining and maintaining a reverse mortgage. These include an origination fee, which covers lender administrative expenses. For Home Equity Conversion Mortgages (HECMs), the most common type, this fee is capped, typically at a percentage of the home’s value, up to a maximum amount.

Borrowers also pay a Mortgage Insurance Premium (MIP) to the Federal Housing Administration (FHA), which insures HECMs. This includes an initial MIP and an ongoing annual MIP, both calculated as a percentage of the home’s value or outstanding balance. These premiums, along with servicing fees, are typically added to the loan balance, further reducing the homeowner’s available equity. All these charges contribute to increasing debt, impacting the home’s remaining value.

Reduction of Home Equity and Inheritable Assets

The escalating loan balance of a reverse mortgage directly impacts home equity, which diminishes over the loan’s life. As interest and fees are continuously added, the unencumbered value of the home decreases. This process can significantly reduce available equity, potentially leaving little or none for the borrower or heirs in the future.

For many homeowners, their residence represents a substantial part of their wealth, often intended as an inheritance. A reverse mortgage converts equity into cash, reducing the asset that can be passed down. While HECMs have a “non-recourse” feature, ensuring heirs won’t owe more than the home’s value, remaining equity after repayment will be significantly less, or zero.

Heirs inheriting a home with a reverse mortgage must address the outstanding balance, which typically becomes due and payable upon the borrower’s death or permanent departure from the home. They have a limited timeframe to repay the loan, sell the property, or allow the lender to take possession. This can force heirs to sell the home to satisfy the debt, even if they wish to retain it.

Ongoing Borrower Responsibilities and Default Risk

Despite not making monthly mortgage payments to the lender, reverse mortgage borrowers retain ongoing home responsibilities. Homeowners must pay property taxes, maintain homeowners insurance, and keep the property in good repair. Failure to meet these obligations can lead to serious consequences.

Lenders assess a borrower’s ability to cover these property charges during the application process. If a borrower fails to pay property taxes or insurance, or neglects home maintenance, the loan can default. This means the entire loan balance, including accrued interest and fees, becomes immediately due and payable.

A loan default can result in foreclosure, where the lender takes possession of the home to recover the outstanding debt. This is a risk for borrowers who might assume a reverse mortgage eliminates all financial obligations. Maintaining the property as the principal residence is also a continuing responsibility; extended absences can trigger the loan becoming due and payable.

Implications for Non-Borrowing Spouses and Relocation

Reverse mortgages present challenges for non-borrowing spouses and in relocation situations. A non-borrowing spouse is married to the borrower but not listed on loan documents. Historically, if the borrowing spouse passed away or moved permanently, the non-borrowing spouse risked losing their home, as the loan became due and payable.

Recent changes offer protections for eligible non-borrowing spouses. These allow them to remain in the home without immediate repayment, provided they meet criteria like being married to the borrower at closing and maintaining the home as their principal residence. However, even with these protections, the non-borrowing spouse receives no further loan disbursements, and any remaining line of credit is frozen.

A reverse mortgage also has implications if the borrower moves out permanently, such as to assisted living or a nursing home. If the borrower is away from the home for an extended period, the loan becomes due and payable. This can force the home’s sale to repay the loan, which may not align with long-term care plans.

Complexity and Informed Decision-Making

Reverse mortgages are complex financial products with terms and conditions that can be challenging for the average person to fully understand. Their intricate nature, including how the loan balance accrues, fees, and repayment conditions, requires careful consideration. Misinterpreting these aspects can lead to unexpected financial outcomes.

To address this complexity, mandatory counseling is required for all HECM borrowers before obtaining a reverse mortgage. This counseling, provided by HUD-approved agencies, ensures prospective borrowers grasp the loan’s implications, risks, and responsibilities. Counselors explain how the loan works, its costs, drawbacks, and ongoing obligations like property taxes and home maintenance.

Despite counseling, borrowers may struggle to comprehend every detail or have preconceived notions. A lack of complete understanding or underestimating long-term impacts is a downside. Individuals should actively engage in counseling and seek clarification to make an informed decision.