Reverse Mortgages: Easy Cash or Big Financial Mistake?
During a 401k retirement optimization workshop my client asked me about a reverse mortgage that her elderly father was considering. He needed the money to pay medical bills, she explained. I researched reverse mortgages to understand if this was a fiscally smart decision or another way that financial institutions were taking advantage of cash-strapped or naive elderly people. I thought I’d share what I found with those of you who have elderly parents or are thinking of this as a way to fund part of your retirement.
Spoiler Alert: Reverse mortgages can be a huge financial mistake. I’ll explain why.
Reverse mortgages sound like a good idea—after all, who wouldn’t want a dream monthly retirement income paid for by their house! But here’s the truth: Reverse mortgages are major rip-offs. In fact, over 100,000 reverse mortgages have led to foreclosures and evictions.
Why are reverse mortgages so bad? Let’s take a look at what a reverse mortgage is at its core, and why it’s nothing more than a predatory program designed to take advantage of you.
What Is a Reverse Mortgage?
A reverse mortgage is a type of mortgage that’s only available to homeowners aged 62 or older who have already paid off a good chunk (or all) of their home’s original mortgage loan.
Similar to a traditional second mortgage, a reverse mortgage allows eligible homeowners to access their home equity — that’s the value of their home minus what they still owe — in the form of either a lump sum, line of credit, or fixed monthly payment from the lender to the borrower.
Borrowers can only get a reverse mortgage on a single- or multi-family home (or condo) no bigger than a fourplex that serves as their primary residence. Additionally, borrowers must be free of any federal debts, like unpaid taxes.
How Does a Reverse Mortgage Work?
Getting a reverse mortgage works like a regular mortgage — you apply and then wait for the lender to approve you. Along with the qualifications we just went over, lenders will evaluate your finances to make sure you can afford to pay for other expenses you’ll still be on the hook for, like taxes and insurance.
Also similar to a traditional mortgage, homeowners who take out a reverse mortgage put up their house as collateral for the loan — if you don’t live up to the terms of the loan (like miss a payment), you lose your house.
How Do You Pay Back a Reverse Mortgage?
Companies who offer reverse mortgages will really play up the fact that if you take one out, you won’t owe monthly payments. That is true, but remember: We’re still talking about a loan here. You may not make monthly payments, but you will pay the lender back eventually. After all, they’ve got to make money somehow.
Here’s how that works: As long as you continue paying your property taxes, homeowners’ insurance, and other expenses related to your home, you won’t owe the mortgage company anything while you still live in your home. But when you stop living in your home, either because you move out, go to assisted living or a nursing home, or die, the balance on your reverse mortgage becomes due in full.
Yes, that means your family will be on the hook for paying your loan back if you die, unless they decide to let the bank have your home. In addition, if only one spouse is on the reverse mortgage, the other spouse or children living there have to move out or pay back the loan immediately.
Oh, and did I mention that interest on your reverse mortgage starts building from the moment you take it out and doesn’t stop until it’s paid back? Plus, reverse mortgages always come with a bunch of ridiculous fees.
This has led to a large number of foreclosures when an elderly person dies or goes to a nursing home.
Risks of a Reverse Mortgage
There are plenty of these. You could lose your home. This one’s the kicker: Lots of reverse mortgage lenders will try to sweet talk you into believing it isn’t possible to lose your home. But what do you think will happen if you use up all the money from your reverse mortgage and start missing bills like your property taxes or homeowners’ insurance? Here’s a spoiler: You’ll lose your home. Plain and simple.
You’ll pay lots of fees. Reverse mortgages are loaded with extra costs. Some of the biggest are the origination fee, mortgage insurance premium, closing costs, and servicing fees. All those costs add up quickly — we’re talking close to $10,000.
You could be getting roped into a scam. Reverse mortgages stink, but most lenders are legit. There are, however, some bad guys out there. The reverse mortgage industry has had problems with scams and fraud over the years and, if you’re not careful, you’ll wind up as the latest victim.
The interest will add up quickly. Even though you don’t pay monthly payments on a reverse mortgage, your lender will start charging you interest from the moment you take it out. And they won’t stop until it’s all paid back. If you take out a $150,000 reverse mortgage at 5% interest on a $200,000 house, and you don’t pay it back for 25 years, you (or your family) will owe a whopping $113,000 in interest.
You’ll likely owe more than what your home is worth. Advertisers promoting reverse mortgages love to spin the old line: “You will never owe more than your home is worth!” That is a complete lie. Let’s go back to the scenario we just looked at, where you owe $113,000 in interest on a $150,000 loan. Add those two numbers together, and the total amount you’d owe comes to $263,000 — for a $200,000 home.
You could leave your family a huge mess. We’ve talked about how it’s very possible to not owe your lender a dime on a reverse mortgage until you die. Well, if you do die before paying off your loan, your family will have two options: Pay back the entire amount you owe, or give up your home to the bank.
Alternatives to Reverse Mortgages
Literally anything would be better than taking out a reverse mortgage. If you haven’t reached retirement age, there are three main levers to having more savings in retirement (I review this in my retirement optimization workshop):
Work longer: The later you retire and begin taking money out of your retirement account can make a big difference. Not only are you letting the money grow but you’re not withdrawing money.
Change your retirement investments: Choosing lower cost index funds and paying lower fees can dramatically increase the amount you have in retirement, especially if you do this early in your career. You can also change your investments to prudently invest more aggressively based on your timeframe to retirement.
Save more: Increasing the amount you save can have a big impact on your retirement savings, especially if you do this early in your career.
If you’ve already retired and need cash, a better alternative is to sell your home and downsize to something cheaper and put the cash in a high interest money market account. I’d suggest speaking to an attorney who specializes in long-term healthcare and Medicaid planning for the elderly before selling your house.
I hope I’ve convinced you that if anyone suggests a reverse mortgage to you or your family, just run and don’t listen to their sales pitch no matter what they say.
NOT FINANCIAL ADVICE
The information contained in this article is for informational purposes only and shall not be understood or construed as financial advice. I am not an attorney, accountant, or financial advisor, nor am I holding myself out to be. I do not accept any fees or commissions from anyone or any financial institution.
I’d love any feedback on these articles.
