Should You Do a Reverse Mortgage?
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 make any loan repayments. Instead, interest accrues and the loan is 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. The older you are at the time of the loan, the more of the home’s equity you’ll be able to borrow against.
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 repayment of the loan and the accrued interest 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?
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 responsibilities, the lender has the right to evict you and sell the property.
Is it expensive to borrow in this manner?
Yes. The fees involved in obtaining a reverse mortgage are high and this is the main reason I recommend against them in most circumstances. These expenses fall into three categories:
- Closing costs — a 2% lender origination fee, title insurance, plus the usual appraisal, inspection, attorney, and recording fees
- FHA mortgage insurance — ongoing 0.5% insurance fee
- 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 but will leave you worse off over the longer term. You don’t have to look too far to find tragic stories like this or this.
What are the alternatives?
Because of the high fees involved, as well as you 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 tap into a reverse mortgage is a yellow flag that you’re living beyond your means and a reverse mortgage won’t necessarily fix that. 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 would 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.
A better alternative is to sell your home and find a less costly place to live. You will then have the equity from the sale of your home to live on and, with some assistance from a financial planner, you can calculate a budget that is affordable for your available resources. While this may be more painful and disruptive in the short run, it will set you up for more financial security in the longer run.