Why Are Reverse Mortgages a Bad Idea?

Reverse mortgages offer homeowners aged 62 and older a way to convert a portion of their home equity into cash without selling their property or incurring new monthly mortgage payments. This financial tool can provide funds for various needs, from covering living expenses to making home improvements. Understanding the mechanics, costs, and repayment obligations associated with these loans is important.

Core Mechanics of a Reverse Mortgage Loan

A reverse mortgage operates differently from a traditional mortgage where a borrower makes regular payments to a lender. Instead, the lender makes payments to the homeowner. Unlike a conventional loan, the outstanding loan balance increases over time rather than decreasing. Interest accrues on the outstanding loan balance, and this interest is then added to the principal, leading to a compounding effect.

The loan balance continues to grow as the homeowner receives funds and as interest and other charges accumulate. A significant feature of federally insured reverse mortgages, known as Home Equity Conversion Mortgages (HECMs), is their non-recourse nature. This means that neither the borrower nor their heirs will ever owe more than the home’s value at the time the loan becomes due and payable, regardless of how large the loan balance has grown. This protection limits the financial liability to the value of the home itself, preventing lenders from pursuing other assets of the borrower or their estate.

Homeowners have several options for receiving the proceeds from a reverse mortgage. These include a lump sum payment at closing, or a line of credit for drawing funds as needed, with interest only accruing on the amount actually used. Monthly payments can also be selected, either as fixed payments for a set period (term option) or for as long as at least one borrower lives in the home (tenure option). These various disbursement methods provide flexibility, but each has different implications for the growth of the loan balance and the homeowner’s remaining equity.

Costs and Financial Implications

Reverse mortgages involve various upfront and ongoing costs that can significantly impact the homeowner’s available equity over time. One of the initial expenses is the origination fee. For HECMs, this fee is typically structured as 2% of the first $200,000 of the home’s value and 1% of the amount exceeding $200,000, with a cap of $6,000. Some lenders may charge a minimum origination fee of $2,500, regardless of the home’s value.

Another substantial cost is the Mortgage Insurance Premium (MIP). There is an upfront MIP, currently set at 2% of the home’s appraised value or the maximum lending limit, whichever is less. This initial premium is typically financed into the loan, reducing the immediate cash available to the borrower. Additionally, an annual MIP of 0.5% of the outstanding loan balance is charged and accrues monthly, further increasing the total loan amount.

Beyond these major fees, homeowners also face other closing costs similar to those in a traditional mortgage. These can include appraisal fees, title insurance, recording fees, and credit report charges. A mandatory counseling session fee, typically ranging from $125 to $200, must also be paid out-of-pocket by the borrower. Servicing fees are also added to the loan balance monthly, usually ranging from $30 to $35. These various fees, combined with the compounding interest, mean that the loan balance grows at a faster rate than just the funds disbursed to the homeowner, thereby reducing the home equity available over the life of the loan.

Loan Maturity and Repayment Obligations

A reverse mortgage does not have a fixed repayment date; instead, it becomes due and payable when specific “maturity events” occur. The most common triggers include the death of the last surviving borrower or if the last borrower permanently moves out of the home, such as selling the property or relocating to a care facility for more than 12 consecutive months. The loan also matures if the homeowner fails to meet the terms of the loan agreement, which includes obligations like paying property taxes and homeowners insurance, or maintaining the property in good condition.

When a reverse mortgage matures, the full loan balance becomes due. While the loan is non-recourse, heirs must decide how to address the debt. Heirs typically have a limited timeframe, often 30 days after receiving a “Due and Payable” notice, to inform the lender of their intentions, with extensions possible up to six months or more. Their options generally include selling the home to repay the loan and keeping any remaining equity.

Alternatively, heirs can choose to keep the home by repaying the loan balance themselves. If the loan balance is higher than the home’s market value, heirs can often pay off the loan at 95% of the home’s appraised value, with federal mortgage insurance covering the difference. If heirs do not wish to keep the home or cannot repay the loan, they can sign a “deed-in-lieu of foreclosure,” transferring ownership of the property to the lender. This structured repayment process ensures that while the loan must eventually be satisfied, the non-recourse feature protects the borrower’s estate and heirs from unexpected personal financial burdens.