What Is the Downside of Getting a Reverse Mortgage?

A reverse mortgage allows homeowners, typically those aged 62 or older, to convert a portion of their home equity into cash without taking on new monthly mortgage payments. While this financial tool can offer flexibility by providing funds for living expenses, home repairs, or other needs, it comes with specific drawbacks. Understanding these potential downsides is important for anyone considering a reverse mortgage.

Rising Loan Balance and Costs

The loan balance of a reverse mortgage grows over time, rather than decreasing like a traditional mortgage. This occurs because interest accrues on the principal amount borrowed, as well as on accumulated interest and fees, a process of compounding interest. Since borrowers are not required to make monthly payments, this compounding can lead to an increasing debt that reduces the home’s equity.

Beyond the compounding interest, other costs contribute to the growing loan balance. Lenders charge origination fees, which cover the processing of the loan application. For a Home Equity Conversion Mortgage (HECM), the origination fee is often capped at $6,000.

Mortgage Insurance Premium (MIP) is another cost. There is an initial MIP paid at closing, which for HECMs is 2% of the home’s value or the maximum claim amount, whichever is less. An annual MIP of 0.5% of the outstanding loan balance is also charged throughout the life of the loan. These insurance premiums protect the lender by ensuring the loan will not exceed the home’s value, but they add to the total debt.

Servicing fees are also charged for managing the loan and are added to the outstanding balance. Other closing costs, similar to a traditional mortgage, include appraisal fees, title insurance, recording fees, and credit report fees. These upfront and ongoing costs, combined with compounding interest, can erode the home equity available to the borrower or their estate over time.

Obligations to Maintain Home Ownership

Even without monthly mortgage payments, reverse mortgage borrowers retain financial responsibilities related to their home. Failure to meet these obligations can lead to default and potentially foreclosure. Borrowers are required to keep property taxes current, ensuring these assessments are paid on time.

Maintaining homeowner’s insurance is a requirement. This insurance protects the property from damage and is necessary for the duration of the loan. Borrowers must also keep the home in good repair, addressing maintenance to preserve the property’s value. If the property is part of a homeowners association, any associated fees must also be paid.

If a borrower fails to meet any of these obligations, the loan can go into default, making the entire loan balance due and payable. Lenders may provide a notice period to resolve the default. If the borrower cannot correct the issue, the lender has the right to advance funds to cover these costs, which increases the loan balance, or initiate foreclosure proceedings. This means that even without a traditional mortgage payment, a borrower can still lose their home if they neglect these ongoing responsibilities.

Implications for Inheritances

A reverse mortgage directly impacts the amount of home equity available to heirs upon the borrower’s passing. As the loan balance grows due to accrued interest and fees, the remaining equity in the home decreases, leaving little or no inheritance from the property.

A feature of federally insured reverse mortgages, such as HECMs, is their non-recourse nature. This means that heirs cannot owe more than the home’s value at the time the loan becomes due. If the loan balance exceeds the home’s market value, the lender cannot pursue other assets from the borrower’s estate or heirs to cover the difference. Federal mortgage insurance covers any shortfall to the lender.

When the loan becomes due, usually upon the death of the last borrower, heirs face several options. They can sell the home to repay the loan, which is the most common choice. Heirs can also choose to keep the home by repaying the loan for no more than 95% of its appraised value, or the full loan balance, whichever is less. If heirs do not wish to repay the loan or sell the property, they can simply deed the home to the lender. Heirs are given a timeframe, six months, to decide on a course of action and settle the loan, with extensions available.

Navigating Life Changes and Repayment Triggers

A reverse mortgage becomes due and payable upon certain life events, which can occur unexpectedly. The requirement is that the home must remain the borrower’s principal residence. If the borrower no longer lives in the home for the majority of the year, the loan becomes due.

The loan also becomes due when the last borrower on the loan dies, sells the home, or moves out permanently. A permanent move is defined as being away from the home for more than 12 consecutive months, such as relocating to a nursing home or living with family. This can create a situation if unforeseen medical or long-term care needs arise, forcing a sale of the home at an inconvenient time.

The situation for a non-borrowing spouse has historically been a concern. If a spouse was not listed on the loan, they could face foreclosure upon the death or permanent move of the borrowing spouse. For HECMs issued on or after August 4, 2014, federal rules offer protections for eligible non-borrowing spouses. These protections allow an eligible non-borrowing spouse to remain in the home under conditions, including being named in loan documents, being married to the borrower at closing, and continuing to occupy the home while paying taxes and insurance. While these rules defer the loan’s repayment, the non-borrowing spouse will not continue to receive loan payments, and any lines of credit will be frozen.