Chances are, you’ve heard of reverse mortgages. But do you really know how they work? There are many professionals on both sides of the fence. One side will try to sell you on the upsides of reverse mortgages, and the other will warn you of the downsides. Let me tell you this, objectively: reverse mortgages can be a good solution for a certain type of consumer, but they are complicated. Understand how they work before you decide on this option.
Understand the Cost of the Benefits
As we have all learned over time, sometimes things that seem too good to be true are just that. Obtaining a reverse mortgage is an important financial decision; they are very expensive products and should be used only when they’re appropriate for the situation. It’s essential that you understand the actual price and implications, not just the upfront ones. Reverse mortgages can be beneficial and worth the costs, but consider the disadvantages before making your decision. Remember: a mortgage salesperson is not a financial planner and does not have a fiduciary responsibility to your best interests. Get objective advice beyond the required counseling meeting!
You’ve probably heard plenty about the benefits of reverse mortgages. They can:
- Stop your monthly mortgage payments
- Offer access to some of your equity without monthly payments
- Provide flexibility in your use of the funds:
- Credit line for emergencies
- Additional monthly stream of income
- Lump sum distributions
- Or a combination of any of the above
- Give access to tax-free money (as is the case in all equity loans)
- Qualify you easily (qualification is based on the property, not income)
- Allow you to stay in your home
- Offer independence and freedom of choice
Of course, all of these benefits sound great! But is a reverse mortgage the panacea? Is it the best solution to meeting life objectives if you have limited funds (equity-rich, cash-poor) and increased income needs? Yes, these types of loans can do all this, but make sure you thoroughly understand the high cost and terms, compared to other financial alternatives, before proceeding. Remember: if it sounds too good to be true…
I want to clarify here: I do think that reverse mortgages can be a great product, especially for older seniors who need to facilitate costly care needs such as aging in place endeavors or meeting the future needs of a healthy spouse when the other person’s health costs become significant. In fact, reverse mortgages are a part of my tool chest as a financial planner for the elderly. Sometimes it is the best alternative. I am thrilled that the product is evolving quickly and getting significantly better with time. I don’t deny that equity-rich, cash-poor retirees might want to consider leveraging their equity to enhance their lives, but as hassle-free as the reverse mortgage industry tries to make it sound, the cost and financial implications on the future unfortunately get downplayed in light of the benefits—especially for retirees younger than seventy-five. Age is a significant factor in this equation.
What are the Total Annual Loan Costs?
Compare annual percentage rates (APR), not interest rates. To understand how a reverse mortgage really works, think about your current circumstances and how they might change in the future. Consider these factors:
- Even though you’re not writing a check for closing costs, monthly payments, monthly service fees and mortgage insurance, it doesn’t mean you’re not paying for it! Those costs are merely added to the loan balance. You pay compounded interest on all of it, quickly accelerating the loan balance due in the future!
- You may have to pay off a valuable lower rate existing mortgage. Note the reverse mortgage rate is variable and can rise. You will also pay for mortgage insurance and additional service fees. What is the real cost of the money?
- There are other products that are significantly cheaper than reverse mortgages, and possibly other deferred loans that can help you finance home improvements. Deferral on tax payments can also help reduce your present expenses.
- If you reduce your equity quickly, as this product does, what happens if you need those funds in the future to finance expensive elder care? Your reverse mortgage agent may tell you that you can always refinance the reverse mortgage at that time, but front-end fees are very high—usually about 4–8% of the entire loan.
- One of the benefits of reverse mortgages is that you don’t have to repay the loan as long as you live in the home. But if your health care needs change—for example, you have a stroke or develop Alzheimer’s—and must go to a nursing home, you could lose that benefit. If you are out of the house for more than one year, you must then repay the loan.
- You lose your tax interest deduction until the year it is paid off.
- The loan balance grows quickly due to the compounding. Will your heirs be shocked and disappointed when they find out the loan balance that has built up? Perhaps you should discuss reverse mortgages with them before entering into an agreement. They might be able to facilitate other options.
- Is this the best tool to gain liquidity to purchase other things, such as long-term care insurance, annuities and additional real estate?
- Does the property qualify (based on the value and present condition of the home) without your needing to make large repairs?
- Does the net amount you get warrant the front-end fees?
Unfortunately, the pushers of this product often prey on the poor, seizing their home equity in exchange for a pricey promise or dream. The reverse mortgage can impact the aging home owner’s future ability to qualify for other benefits like supplemental social security, Medicaid, and other low-income government loans and services. As a buyer or borrower, be aware before entering into this type of financial arrangement. Frequently the benefits are presented in such a way that they blur the borrower’s understanding of the significant costs and the ramifications. Everything has a cost. Just know your choices and the total price before committing.