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The reverse mortgage is a relatively new loan product, compared to conventional loans and FHA loans that have been around for many decades. Since it is so different from a normal mortgage, it went through a few changes to reach its current incarnation. This article hopes to explain the pros and cons of a reverse mortgage and help people make a wise decision for their needs.
First the Cons of a Reverse Mortgage
We will start with the negatives first in order to get them out of the way. There are not many bad sides to a reverse mortgage, but it is important to understand each drawback.
Upfront Insurance Costs
Borrowers are asked to pay normal closings costs since this is a mortgage. However, if the borrower receives at least 60% of the Principal limit either at the time of closing or combined within the first year, the lender will assess an upfront mortgage insurance premium. This amount can be significant for most borrowers. Thankfully, the upfront insurance can be added to the loan balance, saving the borrower from the hefty expense at the closing. If the borrower is simply looking to use a reverse mortgage for a short-term fix, these costs do not make sense and a reverse mortgage may not be the right financial decision at this time.
Be Wary of Vultures
No, we are not talking about birds that feed on dead prey, but rather fair-weather friends and distant relatives that may try to separate an older person from their recently acquired lump of cash. Relatives may approach the borrower with a “once in a lifetime investment opportunity” that turns out to either be a hoax or simply a bad idea. Other forms of vultures may be people posing as home improvement experts trying to convince a person to spend excessive money on unneeded repairs to their home.
Basic Maintenance Still Required
One thing that catches a lot of seniors by surprise is the fact that the homeowner’s insurance, annual property taxes and basic maintenance of the home are still the responsibility of the homeowner. The reverse mortgage does not magically pay these items from the proceeds each month. This is one reason why a change was made in the reverse mortgage guidelines requiring prospective borrowers to complete a financial counseling program before receiving the loan.
Some seniors will request an escrow service with their reverse mortgage. This service takes a part of the monthly proceeds and sets it aside to cover the costs of annual property taxes and home owner’s insurance.
If the financial assessment and counseling session proves that the borrower may have a strong chance of failing to pay the basic maintenance items, the lender may require a LESA. This is an acronym for Life Expectancy Set Aside. Depending on the borrower’s current age along with the expected remaining life, the set-aside amount will be calculated to cover the escrow amounts and leave no chance of failure to the borrower.
The counseling goes over basic personal finance concepts and provides the borrower a chance to understand the full impact of the loan before signing on the dotted line.
Possible Impact on Other Benefits
Another con of the reverse mortgage is the possibility of having a negative impact on benefits, like Medicaid. The presence of more cash in their accounts can reduce, or even eliminate, Medicaid benefits for some individuals. This would be a terrible situation for many people that depend on Medicaid to cover some or all of their doctor expenses and prescription medication.
Along the same lines, borrowers need to be careful not to take too much of the available funds in a short amount of time. The goal of the reverse mortgage is to assist seniors in their later years, not be a primary source of income. The interest that will accrue as the balance grows will be much higher than traditional rates on savings accounts, CD’s or money market accounts.
It is difficult for many senior citizens and their immediate family to consider selling a home that they have owned for many years. However, it is unwise for a borrower to pay off a traditional mortgage with a reverse mortgage and find themselves in a worse financial situation within a year or two.
Now for the Pros of a Reverse Mortgage
We have discussed the negative possibilities with a reverse mortgage. Let’s take a moment to look at the positives that can be realized from this type of loan.
Seniors Can Remain at the Home
The biggest appeal of the reverse mortgage is the fact that borrowers are allowed to stay in the home as long as they wish without the worry of repaying the loan. The loan will be repaid, but only after the borrower has moved away from the property.
For example, suppose someone decides to take out a reverse mortgage at age 68. They choose a loan that will provide them monthly payments for 20 years. After the payments stop, the borrower continues to live on for 7 years. During that 7-year period, the borrower is not required to make any payments towards the reverse mortgage debt. Only after the borrower leaves the home, or passes away, will the debt be repaid by the sale of the property.
Qualifying is Much Easier
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Although a few changes have been made to the reverse mortgage in recent years, it is generally easier to qualify for this kind of loan compared to a conventional loan. Basically speaking, so long as the borrower has reached the appropriate age and has significant equity in their home, they typically can qualify for the loan.
Seniors can Use Proceeds as They Wish
The money obtained from a reverse mortgage is not subject to federal income tax and is not earmarked for any specific purpose. A borrower can use the funds to purchase a car, take a vacation, pay medical bills, improve their home or even give the money to young relatives for college expenses.
The only requirement comes in the form of an existing mortgage or another type of lien on the home. Any mortgage or lien must be paid off with the reverse mortgage loan. This puts the reverse mortgage in 1st position as a lien.
Money is Guaranteed
It is unfortunate that some borrowers fall on hard times and find themselves unable to repay their mortgage. In these instances, the lender takes possession of the home and sells the property to pay off the debt. The homeowner must move out in this situation.
However, in the case of a reverse mortgage, the homeowner is RECEIVING money from the lender. Therefore, the federal government guarantees that the payments will be made. In fact, banks can be forced to pay a late charge to the homeowner if the monthly payment does not arrive on time.
Furthermore, in the case of borrowers that are frugal with the reverse mortgage and do not spend the entire equity, the government also guarantees that the available amount will always be accessible. Regardless of the financial condition of the lender, they cannot deny a senior access to any available equity on their mortgage.
Payoff Can be Less
The recent mortgage crisis forced lenders to reevaluate how they lend money and also how properties are appraised for loans. The crisis left many people owing more on their home’s than the property was worth.
In the event that a reverse mortgage borrower sees a decline in their property value, they have an option to pay off the mortgage for less money. The rules state that if the property values drop below the existing loan balance, the borrower may choose to pay 95% of the home’s appraised value.
Use Equity to Buy a Home
One of the most ingenious ways of using a reverse mortgage is to tap in the equity and buy another home. Many seniors find themselves in need of moving to a different property for a variety of reasons. Some people simply no longer need the space of a home designed to house a large family. Others may be facing medical issues and need a home without two stories, or something that is more accessible for a wheelchair. Then there are people that may need to move in order to be closer to relatives or medical professionals.
Whatever the reason, using the equity to buy another home is a very wise move. Consider that most seniors have paid for years to get the balance down on their home. Hopefully, the home has also appreciated in value. This will allow the person to sell their home and make a very large down payment on their next home, most of the times at least 50% down. In order to cover the remaining balance on the purchase of the new home, the senior citizen would use a reverse mortgage instead of a traditional mortgage.
By paying 50% or more down and using a reverse mortgage for the remaining amount, the senior citizen will not be required to pay any payments on the new home. And they can live in the home for the remainder of their life.
Final Thoughts On The Pros and Cons of a Reverse Mortgage
With proper planning, a reverse mortgage can be a huge benefit to many seniors. However, it will take some time to review possible scenarios, along with current financial needs, to determine if the loan is the right choice for you.
Additional Reverse Mortgage Resources:
What A Reverse Mortgage Is by Kevin Vitali
Reverse Mortgage Changes via Medium
How Reverse Mortgages Work by Bill Gassett
About the author: This article on the “Pros and Cons of A Reverse Mortgage” was written by Luke Skar of www.MadisonMortgageGuys.com. As the Social Media Strategist, his role is to provide original content for all of his social media profiles as well as generating new leads from his website.
MadisonMortgageGuys.com and team provide award-winning customer service to clients who need to purchase a home or refinance an existing mortgage. Our branch currently serves Wisconsin, Illinois, Minnesota, and Florida.
I would strongly recommend that all reverse mortgage holders notify their next of kin about this loan and the contact info for the lender. If they pass away or fail to make a tax or insurance payment these lenders like to foreclose very quickly.
Well said and great recommendation Gabe!