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Reverse mortgages aren’t inherently bad. They can be a boon to older homeowners who need extra cash flow and understand the details of the loan. On the other hand, reverse mortgages offer an opportunity for scammers to take advantage of homeowners since the loans can be complicated and confusing. In addition, the long-term consequences need to be evaluated.
Essentially, a reverse mortgage allows homeowners age 62 and older access to the equity in their home. As long as the homeowners live in their home, maintain it and pay their property taxes and insurance, they keep it. Instead of making mortgage payments, homeowners receive the cash in a lump sum or installments. Interest on the loan accrues and is repaid when the home is sold. While this sounds simple, it can lead to complications with your future finances that a regular mortgage might not entail.
- Are reverse mortgages a bad idea?
- What’s the safest reverse mortgage?
- What are the downsides to a reverse mortgage?
- Avoiding common reverse mortgage scams
- What are the downsides to a reverse mortgage?
- How to know if a reverse mortgage is right for you
Are reverse mortgages a bad idea?
Yes and no. A reverse mortgage is a bad idea when used in desperation, according to the National Council on Aging, because it can create difficulties for people who are already in financial trouble. If you can’t pay your bills or pay to keep up your home, options such as selling or accessing other programs may be a better solution.
A reverse mortgage can be a good idea when used by people who fully understand the consequences of the loan, their responsibilities to maintain their home and how the loan will be repaid. In addition, it’s important to determine the potential consequences for your spouse, other people living with you and your heirs when the loan must be repaid or you pass away. A reverse mortgage counselor can review these scenarios based on your individual circumstances.
What’s the safest reverse mortgage?
The safest reverse mortgage is one provided by a reputable lender. To find one, it’s best to search on your own rather than respond to an unsolicited invitation to apply for a loan. Contact several lenders and ask them to provide you with details about the costs and fees of loan options. You can start with a list of FHA-approved reverse mortgage lenders.
There are three types of reverse mortgages:
- Single-purpose reverse mortgage. Although these loans are not always available, they do offer an option to borrow a smaller sum of money for a specific reason, such as to repair your home.
- Home-equity conversion mortgage (HECM). The HECM reverse mortgage is a federally-insured reverse mortgage that requires reverse mortgage counseling. It is generally considered the safest type of reverse mortgage because lenders and borrowers must comply with FHA requirements.
- Proprietary reverse mortgage. These are private loans typically used to borrow larger amounts than a HECM loan for people with a valuable home and significant equity.
In addition to choosing an FHA-insured HECM reverse mortgage, you can protect yourself by shopping around for a loan from several banks offering reverse mortgages, taking the time to understand all the details and getting unbiased reverse mortgage counseling. With every legitimate reverse mortgage, you also have a 3-day window that allows you to back out without penalty even if you have signed the paperwork.
What are the downsides to a reverse mortgage?
Most homeowners who take out a reverse mortgage use the funds to pay off their existing mortgage, pay other debt or supplement their income to make it easier to stay in their home, according to the National Council on Aging. That sounds simple enough, but the truth about reverse mortgages is that they do have some disadvantages.
A reverse mortgage isn’t right for everyone and could lead to financial issues in the future for you or your heirs. Here’s why:
- The reverse mortgage is only valid when you live in the property, so if you must move for health reasons or other issues, your loan must be repaid with cash or through the sale of the house.
- If you can’t pay your taxes or insurance or an inspection finds your house in disrepair, you could face foreclosure.
- If you want to leave your property to your heirs as an inheritance, a reverse mortgage could severely deplete the value of the house. There may be no equity available for your heirs.
- If you die and there are other relatives or people living in the house, they may have to leave if they are not listed on the reverse mortgage.
There are the most common drawbacks to reverse mortgages. However, some of these issues can be addressed with careful planning.
If you choose a home equity conversion mortgage (HECM) and the loan balance is higher than the value of your home when you pass away or move, you and your family members won’t need to pay the difference, but the lender will own the home. Alternatively, your family members can buy the house at 95% of the appraised value.
If the loan balance is less than the value of your home, your heirs can inherit any profit from the sale of the house. If they want to live in the property, they will need to pay the reverse mortgage, which they may be able to do with a traditional mortgage if they qualify.
Avoiding common reverse mortgage scams
In addition to the possible disadvantages of a legitimate reverse mortgage, another concern is the prevalence of reverse mortgage scams. Among the most common scams are:
A real estate agent or lender may try to convince you to borrow from your home equity with a reverse mortgage to buy another property that will then be sold for a profit. The problem is that you’re putting your home in jeopardy for something that isn’t guaranteed to be profitable — but will put money in the pockets of the agent and lender for their fees.
A financial advisor or a salesperson may try to convince you to take out a reverse mortgage to buy an annuity or make an investment. It’s generally not a good idea to borrow money for investments, especially against your home equity.
Fraud by friends and family.
Sadly, some seniors are victimized by people they know who encourage them to take out a reverse mortgage to provide them with cash or an early inheritance. Get mortgage counseling if someone is pressuring you to take out a reverse mortgage.
Home improvement contractor fraud.
A contractor may recommend that you make a major repair — such as replacing your roof — and pay for it with a reverse mortgage. Before agreeing to the work or applying for the mortgage, consult other contractors and get reverse mortgage counseling.
Payment relief fraud.
A lump-sum reverse mortgage could seem like a good way to pay off medical bills, a mortgage or other debt, but be wary: Some companies that offer to pay off all your debt with a reverse mortgage are not legitimate. You could end up draining your equity and find that the debt has not been paid.
To avoid being victimized in a reverse mortgage scam, the FBI recommends the following:
- Don’t respond to unsolicited ads.
- Don’t sign anything you don’t understand.
- Don’t accept payment for a home you didn’t buy.
- Find your own reverse mortgage counselor. You can find one through HUD here.
How to know if a reverse mortgage is right for you
A reverse mortgage counselor can help you understand the pros and cons of this loan product for your personal situation. Some homeowners choose a reverse mortgage line of credit for the peace of mind of knowing they can access their home equity without payments if necessary. Others choose one to solve a specific need.
Make sure you're able to verbalize in clear terms, why you may want a reverse mortgage, and learn about the consequences of the loan before you apply for one. As with any financial decision, it's important to make an informed decision in the context of your total financial profile.
Be sure to explore potential alternatives to reverse mortgages before committing to a single option, as there are plenty of other loan types that may meet your needs. These include home equity lines of credit (HELOC), cash-out-refinances and personal loans.