A reverse mortgage can make sense in some circumstances for seniors who have significant home equity or own their home outright. However, there are a lot of reverse mortgage pitfalls to watch out for, including high fees, complex rules, and scams. Learn the red flags you should look out for if you’re considering a reverse mortgage.
How a Reverse Mortgage Works
A reverse mortgage is a type of loan that allows homeowners age 62 and older to convert part of their home equity into income. Unlike a traditional mortgage in which the borrower pays back the lender over time, with a reverse mortgage, the lender makes payments to the borrower. The amount you can borrow depends on several factors, including your age, current interest rates, your home’s appraised value, and whether you’re able to pay for expenses such as property taxes and home insurance. Typically, older borrowers with significant home equity and low mortgage balances will qualify for larger loans. When you take out a reverse mortgage, interest accrues on the loan. That means your balance grows higher each month. Typically, though, you won’t have to repay the loan as long as you’re still living in the home.
6 Reverse Mortgage Pitfalls To Watch Out For
A reverse mortgage can be a good option for seniors who are short on retirement savings or who find that their Social Security benefits aren’t enough to cover expenses. However, reverse mortgages are complex products that sometimes come with significant drawbacks. Consider these six reverse mortgage pitfalls before you tap into your home equity.
Some Reverse Mortgages Have Excessive Costs
Reverse mortgages come with significant fees. At the beginning of the loan, you’ll owe origination fees of up to $6,000 that you will pay to the lender, plus real estate closing costs and an initial mortgage insurance premium that your lender charges and pays to the Federal Housing Administration (FHA). You can pay for these costs with cash or money from the reverse mortgage. If you use reverse mortgage funds to pay these expenses, however, you’ll have less loan money available for other needs. With a reverse mortgage, you’ll also pay ongoing costs including servicing fees to your lender, an annual mortgage premium of 0.5% of the loan balance, as well as the costs of property taxes and insurance. In addition, interest charges are tacked onto your balance each month. To minimize these costs, it’s essential to shop around for lenders. You can also avoid excessive fees by only borrowing the amount you need.
You Could Hurt Your Heirs
A reverse mortgage can be problematic for heirs. The loan will significantly reduce your home equity, which means you’ll leave them a smaller inheritance. If your heirs inherit a home with a reverse mortgage, they’ll have three options: pay off the entire loan balance or 95% of the home’s appraised value, sell the home, or present the lender with a deed in lieu of foreclosure. This can cause significant conflict if there are multiple heirs who disagree about whether to keep the home. If you’re taking out a reverse mortgage, make sure you tell your heirs so they can adjust their expectations and prepare financially if they want to keep the home.
It Could Affect Your Government Benefits
A reverse mortgage won’t affect your Social Security or Medicare benefits. However, you could jeopardize your Medicaid or Supplemental Security Income (SSI) benefits if you don’t spend any money you receive within the same calendar month. Reverse mortgage proceeds that remain in a checking or savings account at the end of a calendar month count as assets for both Medicaid and SSI. Assets exceeding $2,000 for individuals or $3,000 for couples could make you ineligible for both programs. For example, if you’re a single person on Medicaid who received a $3,000 reverse mortgage payment in January and you spent that money by Jan. 31, your benefits wouldn’t be affected. But if you only spent $1,000 and deposited the remaining $2,000, you’d risk losing your benefits if you hadn’t spent the money by the end of the month.
Homeownership Costs Are Your Responsibility
When you take out a reverse mortgage, you’re responsible for property taxes and homeowners insurance. Unlike with a traditional mortgage, where part of your payment goes into an escrow account for these expenses, with a reverse mortgage, you’ll need to budget for these costs. Some lenders have “set aside” options that let you opt to have these expenses deducted from your payments. Maintenance costs are also the borrower’s responsibility. Your lender or loan servicer can inspect your home and require repairs. You’ll typically have 60 days from the date your lender orders repairs to begin making them. If you fail to make repairs, pay property taxes, or maintain insurance, your lender could consider your loan in default.
You Can’t Move Out of Your Home
If you spend more than six months living away from your home for non-medical reasons and you don’t have a co-borrower, your home will no longer be considered your primary residence. You’ll need to pay back the loan, sell the home, or transfer the property to the lender via a deed in lieu of foreclosure. You can spend up to 12 months in a nursing facility if you have a reverse mortgage. After 12 months, you’ll no longer meet the private residency requirement. You’ll need to repay the loan, or sell or surrender the home.
Scammers Target Older Homeowners
Older homeowners are often the target of reverse mortgage scams. Some fraudsters try to sell seniors on a reverse mortgage to pay for costly home repairs or get-rich-quick investments. Identity theft is another common problem. Sometimes, a family member or caregiver will pressure an older homeowner into taking out a reverse mortgage to tap into the funds. Or they’ll impersonate the senior by applying for the loan themselves, using the older person’s Social Security number and other identifying information. They may also pressure the homeowner into signing power of attorney forms so that they can control the loan proceeds. Reverse mortgage loan officers aren’t allowed to sell you financial and investment products, so walk away from any lender that attempts to do so. Also avoid contractors who try to push a reverse mortgage to pay for their services. It’s essential to safeguard your personal information, as well as that of any loved one who could be vulnerable to such scams. If you have concerns about a reverse mortgage, find a HUD-certified counselor online or by calling 800-569-4287. If you suspect reverse mortgage fraud, contact the Federal Trade Commission (FTC), your state attorney general office, or your state’s regulatory banking agency.
How To Avoid Reverse Mortgage Pitfalls
Before cashing in on your home equity, carefully consider all the reverse mortgage pros and cons. A reverse mortgage can provide valuable income during your golden years. However, in some circumstances, they may not be the best option. Because of the high upfront costs, consider reverse mortgage alternatives if you don’t plan to stay in the home for at least several years. In addition, think twice if you hope to leave your home to heirs. Taking out a reverse mortgage is a wise move for many seniors, but to avoid a reverse mortgage nightmare, follow these tips:
Budget for costs related to homeownership, including property taxes, homeowners insurance, mortgage insurance, and maintenance.Communicate your decision to take out a reverse mortgage with your heirs.Spend loan proceeds by the end of each calendar month if you receive Medicaid or SSI benefits.Plan to live in the home as your primary residence.Avoid salespeople who pressure you to take out a reverse mortgage to pay for home projects or investment opportunities.Talk to a HUD-certified counselor before signing reverse mortgage documents.
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