The Pitfalls of Reverse Mortgages: What You Need to Know
Reverse mortgages are a powerful tool that can help homeowners 62 and older access the equity in their homes. Reverse mortgages can help seniors significantly increase their retirement income, allowing them greater peace of mind and a higher quality of life during their golden years. And, in some cases, they can actually eliminate monthly mortgage payments, which can make a huge difference, especially for seniors who are living on a fixed income.
While reverse mortgages have a variety of benefits, they also come with certain restrictions and responsibilities for borrowers. These aren’t necessarily “pitfalls,” but they could be considered as such for homeowners who aren’t aware of them. In this article, we’ll review a few of the major concerns for reverse mortgage borrowers and address each of them.
Reverse Mortgage Borrowers Must Still Pay for a Variety of Costs
Unlike what some borrowers may think, obtaining a reverse mortgage does not mean that you’re no longer responsible for maintaining your home and paying the related expenses of home ownership. Just like regular homeowners, reverse mortgage borrowers still need to pay property taxes, homeowner’s insurance, homeowner’s association fees, and general property maintenance and repair costs. Otherwise, your reverse mortgage borrower could call your loan (and no one wants that). Therefore, you’ll need to make sure you’re already somewhat financially stable and have a decent income or savings before getting a reverse mortgage.
In addition, reverse mortgages themselves have their fair share of costs that borrowers should be aware of. These include origination fees, which pay for the cost of processing the loan. Origination fees vary, but for HECMs, the FHA limits origination fees to $2,500 for homes valued at $125,000 or less. For homes valued at more than this, lenders can charge a maximum rate of 2% of the first $200,000, and a maximum rate of 1% on the value of the home that exceeds $200,000. The FHA limits origination fees for HECMs to $6,000. For proprietary reverse mortgages, origination fees are not capped by the FHA, and therefore vary by lender.
Other than origination fees, reverse mortgage borrowers are also responsible for paying their mortgage insurance premium (MIP). MIP for HECMs involve a 2% upfront payment (which can be rolled into the cost of the reverse mortgage loan), as well as a 0.5% annual payment on the remaining loan balance (which can actually grow over time with certain reverse mortgages). For proprietary reverse mortgages, such as jumbo reverse mortgages, mortgage insurance is usually not required.
Third-party costs can also be an expensive part of the reverse mortgage process. These can include appraisals (which often cost around $450), as well as any required home inspections, title search costs, flood certification fees, pest inspections, and a variety of other potential costs.
Reverse Mortgages Can Affect Medicaid and Social Security Benefits
One potential risk of reverse mortgages is the fact that they could impact your medicaid and social security benefits. In terms of medicaid, a large, lump-sum reverse mortgage payment would be considered an asset, which could impact your eligibility for medicaid and social security. However, line of credit reverse mortgages are less likely to interfere with these benefits. If borrowers spend the money they get from a reverse mortgage during the same month that they receive the funds, the additional income will not be taxable, and won’t interfere with government benefit programs. Despite this, if you plan make use of medicaid and want a reverse mortgage, you should discuss your plans with a financial advisor or another qualified professional before making any big decisions.
Reverse Mortgages May Impact Your Children’s Inheritance
If having your children inherit your family home is important to you, you should think (and plan) carefully before getting a reverse mortgage. While a reverse mortgage might seem like free money, it actually has to be repaid. Much of the time, these loans are repaid by the sale of the home, which usually happens after the borrower(s) have died or moved away. If you get a reverse mortgage, pass away, and the sale price of your home is less than the remaining balance of your reverse mortgage, your heirs won’t be required to make up the difference.
However, if there are excess funds left over after the home sale, they will go to your heirs. Either way, your kids (or heirs) still won’t have your home, unless they can fork up serious cash. If they do want to purchase the home after your death, your heirs will have to pay off the remaining loan balance or 95% of your home’s appraised value, whichever is less.
Despite that, there are some things you can do to get a reverse mortgage and make sure your heirs can probably inherit your home. One way to do this is to take out a term life insurance policy large enough to repay the reverse mortgage. When you pass away, your heirs can cash out the policy and use the money to repay your lender. However, you’ll have to find a policy with monthly premiums low enough that you can afford them.
You Typically Cannot Leave Your Home for More Than 12 Months At A Time
One of the more restrictive aspects of reverse mortgages is the fact that most of them require a borrower to live in the home indefinitely, with the caveat that if they leave, the reverse mortgage will be due. Of course, that doesn’t mean you’ll lose your home if you go to the Bahamas for a few weeks. However, if you get seriously ill and need to move to an assisted living facility or decide to stay with a family member for 12 months or more, your lender could demand immediate repayment. For that reason, reverse mortgages may not be a good idea for extremely old borrowers or those with severe health problems. Like the other “pitfalls” of reverse mortgages, this isn’t necessarily a true pitfall, but it is something that borrowers should be aware of.