Don’t Put Your Mortgage in Reverse

In spite of the reassuring words from Tom Selleck, Henry Winkler, and Fred Thompson, a reverse mortgage doesn’t usually make good financial sense.

What is a reverse mortgage?

It’s an unusual type of loan in which you borrow against your home’s equity but you are not required to repay any principal or interest during your lifetime. The interest, however, does accrue and the principal and interest are repaid either when you sell the home or after your death. (It’s also known as a Home Equity Conversion Mortgage.)

The maximum amount you can borrow is tied to the amount of equity you have in the home, along with your age and the current level of interest rates.

Typically, you would remain in your house until your death and the lender would then take control of the house and sell it. Any remaining proceeds after the loan repayment would go to your estate. If the sale fell short of the outstanding loan balance, the lender would absorb the loss. For a married couple, you would keep the house until the death of the second spouse.

Can you lose your home?

Usually not. As long as you responsibly maintain the home and pay your property tax and homeowner’s insurance, you should be secure in your home. However, if you fail to keep up with these financial responsibilities, the lender has the right to evict you and sell the property.

You don’t have to look too far to find tragic stories like this or this. This is the primary risk you face — losing your home due to running out of cash to maintain it.

Is it expensive to borrow in this manner?

Yes. The fees involved in obtaining a reverse mortgage are high and this is the second reason I recommend against them in most circumstances. These expenses fall into three categories:

  1. Closing costs — a 2% lender origination fee, title insurance, plus the usual appraisal, inspection, attorney, and recording fees
  2. FHA mortgage insurance — ongoing 0.5% insurance fee
  3. Interest rate — typically a bit higher than a standard mortgage

This may not sound like a lot of money — 2% here, a half percent there, and a bit higher on the interest rate — but it will be substantial over time. A reverse mortgage will be an expensive way to get short-term relief and will leave you worse off over the longer term.

What are the alternatives?

Because of the high fees involved, the risk of a late-in-life eviction, as well as being unable to borrow the full amount of your equity, a reverse mortgage should be your last resort, rather than the first place to turn for more cash.

Needing to borrow with a reverse mortgage is a yellow flag that you may be living beyond your means. If you do take out a reverse mortgage, you can find yourself in a worse situation in future years if you do not have enough funds to pay the insurance, maintenance, and property tax. In that situation, you could lose your home and likely have no remaining equity. That’s a dangerous place in which to find yourself at a late stage in life.

The choices you face are to either remain in your home by cutting back your ongoing living expenses or to to sell your home and find a less costly place to live. In either approach, you should create a budget that is affordable for your financial situation. While this may be more painful and disruptive now, it will set you up for more financial security in the longer run.

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