You may have seen ads trumpeting, "A Reverse Mortgage Can Provide The Financial Freedom You Need in Your Retirement" and thought, "Hey, that sounds like a great deal! But is it too good to be true? Is there a catch?"
Well, yeah. Most reverse mortgage ads don't show the full picture, leaving seniors confused about how they really work, according to a recent study by the Consumer Financial Protection Bureau.
Here's the deal: A reverse mortgage is a special type of loan available to homeowners 62 years or older that allows them to convert their home equity into cash. The balance of these loans is due, with interest, when the borrower dies, moves, or sells the house.
So, whether you're intrigued for yourself or watching out for an older loved one, read on -- we'll walk you through the most common misunderstandings about reverse mortgages, what they really are, and whether they make sense for your situation.
What seniors don't understand about reverse mortgages
- A reverse mortgage is a loan, not a benefit. Many seniors don't realize this, according to the CFPB study. That's because many ads imply financial security for the rest of a consumer's life. Some seniors even think that a reverse mortgage will ensure that they can stay in their house forever. But borrowers with a reverse mortgage are still responsible for paying property taxes, homeowner's insurance, and property maintenance. Failing to meet these requirements can trigger a loan default that results in foreclosure. Many reverse mortgage ads fail to mention such requirements.
- A reverse mortgage is not offered by the government. Ads often leave older homeowners with the false impression that reverse mortgages are a risk-free government benefit. Consumers often believe that the federal government provides consumer protections for reverse mortgages -- which it does not, according to the CFPB study.
- Difficult-to-read fine print. Some consumers don't pick up on key aspects of the loan because the loan requirements are often buried in the fine print -- if they are mentioned at all. Many reverse mortgage ads reviewed by the CFPB did not mention critical information such as interest rates, repayment terms, and other requirements.
So, as you can see, it's important to educate yourself on how reverse mortgages really work. They're fairly complicated, and you need to understand the terms and risks. Don't get us wrong, we're not opposed to reverse mortgages. For some people, they're a perfect option. Like picking your mortgage, it all depends on what you need and your financial situation.
Reasons to get a reverse mortgage
- You can't qualify for a home equity loan or line of credit. Reverse mortgages have much looser credit and income requirements than other equity loans (although income requirements have been tightened). For a borrower without the means to obtain other lines of credit and who needs cash flow, a reverse mortgage can be the best option.
- You have sporadic, expensive costs, like medical bills. Mortgage advisor Casey Fleming, author of "The Loan Guide: How to Get the Best Possible Mortgage," says he worked with a married couple with a small home equity line of credit (HELOC) who needed more cash flow after the husband had a stroke. They took out a reverse mortgage line of credit to pay off the HELOC. Then they dipped into the reverse mortgage credit line to pay off bills as needed.
- You're older than the minimum eligible age. The more equity and the older you are, the more money you can draw from a reverse mortgage. You're eligible to get a reverse mortgage at 62, but the longer you wait, the more money you'll have access to and the less likely you are to run out of equity.
- You don't have kids or no one wants the house. Many people go into a reverse mortgage anticipating the bank will foreclose on the home when they are gone, instead of passing it onto the next generation.
Reasons not to get a reverse mortgage
- You're too young. The average life expectancy is 81 years for women and 76 years for men. You don't want to outlive your funds and be unable to pay back the loan. Plan with a financial planner to set aside funds for medical bills and living expenses.
- You can cut costs elsewhere. Remember, it's better to live within your means than to borrow. If you live in a big house in an area with high property taxes, it could make more sense to sell and downsize.
- A HELOC makes more sense. A reverse mortgage is expensive. The more equity you take out and the more your home is worth, the more expensive it gets. This includes an upfront origination fee of up to $6,000, an upfront mortgage insurance fee of 0.5% to 2.5%, monthly mortgage insurance equal to 1.25% of the outstanding loan, a one-time fee for mandatory counseling ( about $125), monthly servicing costs (about $35), as well as refinancing closing costs. Home equity lines of credit cost significantly less. Bear in mind that HELOCs are also open-ended loans, meaning lenders can make money by charging a higher interest rate, so shop around.
- If you want to pass on the home. Paying back a reverse mortgage to keep the home of a parent can be a daunting task. Repaying the loan with interest can make it impossible for the inheritor to save the home.
We said it before, and we'll say it again: Reverse mortgages are complex! More complex than you can fully understand from a 30-second commercial. Before signing off on one, consult with a reverse mortgage counselor to understand and compare costs, payment options, and fees associated with the loan. Don't let your lender choose one for you. To find a government-approved counselor, visit http://www.hud.gov/offices/hsg/sfh/hcc/hcs.cfm or call 800-569-4287.