A reverse mortgage might sound appealing if you think of it as letting your house pay you a monthly dream retirement income!
But are they really that great? No, they’re actually major rip-offs. In fact, over 100,000 reverse mortgages have failed, resulting in foreclosures and evictions!1
Whether you, your parents or grandparents are considering a reverse mortgage, we’ll help you define what it is and how it works so you can see for yourself how reverse mortgages are a predatory product to avoid.
What Is a Reverse Mortgage Exactly?
A reverse mortgage is a type of loan that’s only available to senior homeowners—ages 62 and older—who have plenty of home equity (how much a home is worth, minus how much is owed on it).
As with a second mortgage, a reverse mortgage allows you to access your home equity in the form of a lump sum, a line of credit—or even a fixed monthly payment.
While reverse mortgages give seniors access to large sums of money, keep in mind, this means they’d be borrowing against their house—meaning they’d lose the house if something went wrong. If that sounds crazy, it’s because it is.
How Does a Reverse Mortgage Work?
A reverse mortgage works like a regular mortgage in that you have to apply and get approved for it by a lender. They’ll use a bunch of details about you and your home—from your age to the value of your property—to figure out how much they can lend you.
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To qualify for a reverse mortgage, you must:
- Be at least 62 years old
- Own a paid-off (or at least significantly paid-down) home
- Have this home as your primary residence
- Owe zero federal debts
- Have the cash flow to continue paying property taxes, HOA fees, insurance, maintenance and other home expenses
And it’s not just you that has to qualify—your home also has to meet certain requirements. Single-family dwellings and multi-family units up to fourplexes (as long as you live in one of the units) are eligible for a reverse mortgage.
The Home Equity Conversion Mortgage program (more on that later) also allows reverse mortgages on condominiums approved by the Department of Housing and Urban Development.
How Do You Pay Back a Reverse Mortgage?
If you die before you’ve sold your home, those you leave behind are stuck with two options. They can either pay off the full reverse mortgage and all the interest that’s piled up over the years, or surrender your house to the bank.
So, it might seem like a reverse mortgage is a helpful cash-flow option for people in their retirement, but these mortgages put seniors and their heirs at financial risk.
Types of Reverse Mortgages
Like other types of mortgages, there are different types of reverse mortgages. While they all basically work the same way, there are three main ones to know about:
1. Home Equity Conversion Mortgage (HECM)
The most common reverse mortgage is the Home Equity Conversion Mortgage (HECM). HECMs were created in 1988 to help older Americans make ends meet by allowing them to tap into the equity of their homes without having to move out.
If you’re 62 or older, you can qualify for an HECM loan and use it for any purpose. Some folks will use it to pay for bills, vacations, home renovations or even to pay off the remaining amount on their regular mortgage—which is nuts! And the consequences can be huge.
HECM loans are kept on a tight leash by the Federal Housing Administration (FHA). They don’t want you to default on your mortgage, so because of that, you won’t qualify for a reverse mortgage if your home is worth more than a certain amount.2
And if you do qualify for an HECM, you’ll pay a hefty mortgage insurance premium that protects the lender (not you) against any losses.
2. Proprietary Reverse Mortgage
Proprietary reverse mortgages aren’t federally regulated like the HECM ones. They’re offered up from privately owned or operated companies.
And because they’re not regulated or insured by the government, they can draw homeowners in with promises of higher loan amounts—but with the catch of much higher interest rates than those federally insured reverse mortgages.
They’ll even offer reverse mortgages that allow homeowners to borrow more of their equity or include homes that exceed the federal maximum amount.
This might sound good, but what it really means is a higher amount of debt against your name.
3. Single-Purpose Reverse Mortgage
A single-purpose reverse mortgage is offered by government agencies at the state and local level, and by nonprofit groups too.
It’s a type of reverse mortgage that puts rules and restrictions on how you can use the money from the loan. (So you can’t spend it on a fancy vacation!)
Usually, single-purpose reverse mortgages can only be used to make property tax payments or pay for home repairs.
The main point of these loans is to help keep you in your home if you fall behind on costs like home insurance or property taxes, or if you need to make urgent home repairs. The thing to remember is that the lender has to approve how the money will be used before the loan is given the okay.
These loans aren’t federally insured either, so lenders don’t have to charge mortgage insurance premiums. But since the money from a single-purpose reverse mortgage has to be used in a specific way, they’re usually much smaller in their amount than HECM loans or proprietary reverse mortgages.
Reverse Mortgage Pros and Cons
Before you go and sign the papers on a reverse mortgage, weigh the pros and cons:
For some people, the appeal of a reverse mortgage is that you can access cash for living expenses and you don’t make any monthly payments to the lender or pay the interest until you sell your home. That’s true, but it’s not that simple.
With a reverse mortgage, the money you receive isn’t just falling out of the sky—it’s taken from the equity you’ve built. The bank is literally lending you back the money you’ve already paid on your home while charging you interest at the same time.
This makes no sense! You’re putting yourself back in debt. Deep debt! There are also tons of fees on these loans, making it all worse.
Okay, unfortunately, there are way more cons than pros. But what exactly are the downsides to getting a reverse mortgage? Let’s cover those next.
1. You Can’t Tap Into Your Home’s Full Value
You’re only allowed to tap into a certain percentage of your home’s value—based on several factors like what your house is worth, the amount of equity you’ve built up, and your age.3
But even then, you’re not going to receive the full percentage you qualify for. Why? Because there are fees to pay, which leads us to our next point.
2. You’ll Owe Lots of Fees
Reverse mortgages are loaded with extra costs. And most borrowers opt to pay these fees with the loan they’re about to get—instead of paying them out of pocket. The thing is, this costs you more in the long run!
Here are some examples of reverse mortgage fees:
- Origination fee. Lenders can charge up to 2% of a home’s value in an origination fee paid up front. That’s as much as $4,000 for a $200,000 home.4
- Mortgage insurance premium (MIP). You’ll also be charged an initial MIP (similar to PMI) of 2%, followed by an annual 0.5% MIP. So on a $200,000 loan, that’s a $1,000 annual cost after you’ve paid $4,000 up front!5
- Closing costs. Much like getting a regular mortgage, reverse mortgages include closing costs for things like home appraisals, credit checks and loan processing.
- Servicing fees. These are another monthly expense coming your way with a reverse mortgage.
So before you know it, you’ve sucked out thousands from your reverse mortgage before you even see the first dime!
And since a reverse mortgage is only letting you tap into a percentage of the value of your home anyway, what happens once you reach that limit? The money stops.
Worse still, the interest starts piling up as soon as you’ve signed the reverse mortgage agreement. So the amount of money you owe goes up every year, every month and every day until the loan is paid off.
3. You’ll Likely Owe More Than Your Home Is Worth
The advertisers promoting reverse mortgages love to spin the old line: “You will never owe more than your home is worth!”
But, again, you will owe a large chunk in interest and fees when it’s all said and done. Here’s the math to prove it using our mortgage payoff calculator:
Reverse Mortgage Amount
$150,000 (lump sum)
Reverse Mortgage Interest Rate
Age at Time of Loan
Term Length of Loan
Total Interest Accumulated
Total Owed at End of Term or Death
4. You Could Lose Your Home
If a reverse mortgage lender tells you, “You won’t lose your home,” they’re not being straight with you. You absolutely can lose your home if you have a reverse mortgage.
Think about the reasons you were considering getting a reverse mortgage in the first place: Your budget is too tight, you can’t afford your day-to-day bills, and you don’t have anywhere else to turn for some extra cash.
All of a sudden, you’ve drawn that last reverse mortgage payment, and then the next tax bill comes around. A few days later, the utility bills start piling up.
If you don’t pay your taxes or your other bills, how long will it be before someone comes knocking with a property seizure notice to take away the most valuable thing you own?
Not very long at all. And that’s perhaps the single biggest downside! That’s why you should avoid these predatory financial products.
Talk to a Mortgage Expert You Can Trust
Before you make any decisions on a reverse mortgage, speak with an expert who knows the ins and outs of everything to do with mortgages. Our trusted friends at Churchill Mortgage will equip you with the information you need to make the right decision.