How to Avoid a Reverse Mortgage Nightmare
A reverse mortgage is an arrangement that enables homeowners over the age of 62 to convert home equity into cash. The benefits are appealing: You stay in your home, you get cash for anything you want, and there’s no need to make loan payments. You might even “win” if you live an extraordinarily long life.
Reverse mortgages may be appropriate for some people, but they don’t make sense for everybody. If you and your goals don’t fit the right profile, a reverse mortgage can turn into a nightmare for you and your family. These loans have evolved to become less expensive and more consumer-friendly, but they are still complicated. Perhaps most importantly, getting out of a reverse mortgage can be tricky if your plans change.
Rule Out Alternatives
Before you use a reverse mortgage, evaluate all the alternatives.
You might have other options available, and you can still leave the door open for a reverse mortgage later.
Depending on your housing market, you might benefit from waiting as long as possible before applying for a reverse mortgage. Assuming property values rise and interest rates cooperate (which they might not), you could have more equity to borrow against down the road.
The strategies below can help you delay borrowing or avoid a reverse mortgage altogether. It’s not easy to get out of a reverse mortgage, so you need to be sure that you’re making the right choice.
If you have substantial equity in your home, there are several ways to convert to cash. One option is to simply sell your property. After the age of 62, some owners are ready to wash their hands of the tasks and expenses of maintaining a large home. Downsizing can help you raise money and simplify your life. Whether you buy a less expensive place or start renting, you should be able to free up cash when you sell. Downsizing allows you to skip those reverse mortgage costs, especially if you anticipate moving out of the home anyway,
Sell to Family
If you’re not ready to move out just yet, you might be able to sell to a family member that’s interested in your home. If everything works out, you can even stay in your property, making rent payments to the family member for the rest of your life. At your death, the property becomes vacant, and the owner can do whatever she wants with it. These transactions are complex, but a good attorney and tax advisor can easily do the work for you. Managing relationships and expectations with your family members might be the most challenging part.
Instead of getting a reverse mortgage, can you get a more traditional home equity loan? You’ll need sufficient income to qualify, but you’ll have additional options—and possibly less debt—if this strategy is feasible. Compare the total interest costs and closing costs, and weigh the benefit of additional flexibility that comes with a standard loan.
You might be retired, but is there any work you’re willing and able to do to make ends meet? You’ll save a bundle, and working can help you stay engaged (with potential benefits for your mental and physical health). That said, keep an eye on any impacts to your taxes, Social Security, and other benefits.
Those are just a few ideas. Get creative and see if there’s a perfect solution for your circumstances. Talk with financial advisors and debt counselors to get additional insight before you move forward.
Home for Life
Reverse mortgages work best when you—and a co-borrowing spouse, if you’re married—plan to live in your home for the rest of your lives. The idea is that somebody will sell the home after your death, or your heirs will have substantial assets to pay off the loan (assuming they want to keep the property). Reverse mortgages must be paid off when the last borrower dies or “permanently” moves out of the house. You can potentially meet that requirement when a temporary move somewhere else, such as assisted living, lasts more than 12 months.
In a worst-case scenario, a spouse or partner who is not listed as a co-borrower on the loan might have to move out. The same goes for children or other dependents living in the home with you, which can be extremely disruptive and distressing.
If you use an FHA-insured HECM reverse mortgage, your heirs should not owe more than the home’s appraised value or market value—even if you end up borrowing more than the home is currently worth.
To avoid problems, make a plan for the future, whether it’s alternative housing for survivors or a life insurance policy that can pay off the loan and help everybody stay home.
What if you plan to downsize or move your family somewhere else after borrowing? It’s possible to do so, but it can be complicated. Reverse mortgages tap into your home equity, leaving less value stored in your home. When you sell your current home, you’ll need to pay off the reverse mortgage balance from cash on hand or out of the sales proceeds. If you were flush with cash, you probably wouldn’t have used a reverse mortgage in the first place. Using a reverse mortgage can leave you with less money to spend on your next home.
If you think you might move out of the home before you die, be mindful of your spending. The less you borrow, the more equity you'll have available to spend on your next home. Of course, this strategy can backfire: With a reverse mortgage, it’s possible to repay less than you’ve borrowed—in some situations, you’d be better off borrowing more.
Stay on Top of Things
When you own a home, the expenses and maintenance never end. You need to be especially diligent with a reverse mortgage in place. Your loan can come due—meaning you have to repay all the money or risk foreclosure—if you don’t keep up with routine tasks and expenses.
Your home is the collateral for a reverse mortgage, which protects your lender. As a result, your lender needs to make sure the home is worth as much as possible. A leaky roof might not bother you, but rotting boards and mold inside your home could be an issue when the next buyer does an inspection. You also need to stay current on property taxes and HOA dues. Lenders even demand that you keep adequate insurance: If your home is damaged or destroyed, it needs to be rebuilt so that it’s worth enough to pay off the loan.
If you tend to let things slide, find a way to stay on top of the expenses and maintenance items your lender requires. Budget for regular upkeep so you can pay for repairs when needed. Set up automatic electronic bill payments for your insurance premiums and property taxes so you have fewer things to keep track of.
Minimize Interest Costs
When you borrow money, you pay interest, and that’s generally not an expense you can recover when you sell. So it’s wise to minimize those costs—or make sure you’re really getting your money’s worth.
To Finance, or Not?
You’ll have to pay closing costs to get a reverse mortgage, and you need to decide if you want to pay those costs out-of-pocket or finance them by adding the costs to your loan balance. Financing is appealing because you don’t have to hand over the money when you borrow, but it’s also more expensive over the long term. Because those costs are part of your loan, you’ll pay interest on the extra amount year after year. Paying out-of-pocket hurts more today, but it often works out better financially.
Line of Credit?
You also have several options on how to take the funds from your reverse mortgage. One option is to take as much money as you can—as soon as possible—in a lump sum. Another option is to use your reverse mortgage as a line of credit, taking only what you need when you need it. A line of credit can help you keep interest costs low because it delays your borrowing.
Instead of starting with a huge loan balance and the corresponding interest charges on day one, you borrow slowly. If you’re using your reverse mortgage to supplement living expenses by a few hundred dollars per month, for example, you can spread your borrowing out over many years. What’s more, your available pool of money can potentially grow over time if you use a line of credit.
There is at least one potential drawback to the line of credit that you should be aware of: When you choose the line of credit, you’ll get a variable interest rate on your reverse mortgage. This isn’t necessarily bad, but the fixed rate lump sum could work better in some situations.
Reverse mortgages are powerful financial tools, and they can be extremely helpful in the right situation. Unfortunately, they’re also misused. If somebody suggests that you use a reverse mortgage to buy whatever they’re selling, such as annuities, long-term care insurance, or timeshares, look at their interests and seek advice elsewhere if you suspect any bias.
Your home equity is typically a large pool of money, and that’s attractive to con artists and salespeople looking for extra income. If you use your reverse mortgage money to invest, you’ll need to cover the reverse mortgage expenses just to break even. What’s more, you’re putting your home on the line—risking foreclosure—if you can’t keep up with taxes and maintenance expenses.
Take Counseling Seriously
You’ll have to complete a mandatory counseling session with a HUD-approved counselor to use the FHA HECM program. This isn’t just a hurdle to jump over—it’s an opportunity to learn what you’re getting into. Ask as many questions as you have to, and review lender quotes and numbers with your counselor.
Discuss It With Family
It’s your house and your money, but your family and others may be affected by your decisions. They love you and they want you to be comfortable, but they might also have expectations about keeping the house and possibly living there. If their expectations are unrealistic, let them know, or collaborate and find ways to meet your needs while helping your family with their goals.
What you don’t want is for your heirs to assume that the home will stay in the family simply because you live there until you die. Family members may not understand that they will have to come up with a large sum of money to keep the house. Most heirs won’t have sufficient cash on hand—they’ll have to sell the home or refinance the loan. Let them know about this sooner than later so that they can manage their credit and other loans, making it more likely that they’ll be approved for the refinance loan.