What Is the Negative Side of a Reverse Mortgage?
Learn the essential downsides of reverse mortgages. Understand their long-term impact on your financial well-being and inherited home equity.
A reverse mortgage allows homeowners, typically those aged 62 or older, to convert a portion of their home equity into cash. Instead of making monthly mortgage payments to a lender, the lender pays the homeowner, either as a lump sum, regular payments, or a line of credit. This loan does not require repayment until the last borrower permanently moves out of the home, sells it, or passes away. While reverse mortgages can provide financial flexibility, they also come with significant downsides that warrant careful consideration before entering into such an agreement.
Financial Costs and Growing Debt
A primary concern with reverse mortgages involves the financial costs and the way the debt grows over time. Unlike a traditional mortgage where the principal balance decreases with each payment, a reverse mortgage balance increases as interest and fees accrue and are added to the loan. This means that the total amount owed can grow substantially throughout the life of the loan.
Fees contribute to this growing debt. An initial loan origination fee is charged, which can be up to $6,000, or 2% of the first $200,000 of the home’s appraised value plus 1% of the amount over $200,000, whichever is greater, with a minimum of $2,500. An initial Mortgage Insurance Premium (MIP) is also typically 2% of the home’s value, or the FHA lending limit, and is paid upfront. These initial costs are often financed into the loan, increasing the starting debt.
Beyond upfront costs, ongoing fees compound the loan balance. An annual MIP of 0.5% of the outstanding loan balance is charged and added to the principal each year. Lenders may also charge a monthly servicing fee, generally up to $35. These recurring charges, along with interest on the borrowed funds, are capitalized into the loan, meaning interest is charged on the disbursed amount, accrued interest, and fees.
This compounding effect can significantly reduce home equity over time. In some cases, the loan balance can eventually exceed the home’s value. While federal insurance often covers any shortfall, the homeowner’s equity is consumed by the accumulating debt, leaving less, or no, equity remaining.
Ongoing Homeowner Responsibilities
Homeowners with a reverse mortgage retain responsibilities for the property. Borrowers must continue to pay property taxes and homeowner’s insurance premiums. Failure to pay them can lead to serious consequences.
Maintaining the home’s condition is another obligation. Borrowers must keep the property in good repair to preserve its value, as it serves as collateral. Neglecting maintenance can violate the loan agreement.
A borrower must also continue to use the home as their primary residence. If the home is no longer occupied as the principal residence, such as due to a permanent move, the loan can become due and payable.
Failure to meet these obligations, such as unpaid taxes, lapsed insurance, lack of maintenance, or change in residency, constitutes a default. If a default occurs, the lender can demand immediate repayment, potentially leading to foreclosure and loss of the home.
Impact on Estate and Heirs
A reverse mortgage impacts a borrower’s estate and heirs. The loan becomes due when the last borrower dies, sells the home, or permanently moves out. The accumulated loan balance, including original amount, accrued interest, and fees, must then be repaid.
Heirs typically have a limited timeframe to settle the debt. The most common way to repay the loan is by selling the home. Any remaining equity after the loan is satisfied goes to the heirs. However, as the loan balance grows, the equity available for heirs can be significantly reduced or eliminated.
Most reverse mortgages, particularly Home Equity Conversion Mortgages (HECMs), are non-recourse. This means heirs are generally not personally liable for the debt if the loan balance exceeds the home’s value. The lender’s recourse is limited to the home’s value. If heirs wish to keep the home, they must repay the loan, which can be done by refinancing or using other funds, or by paying 95% of the home’s appraised value if that amount is less than the loan balance. If they choose not to repay or sell, the lender will initiate foreclosure to recover the debt.