8 Reasons Reverse Mortgages Are Dangerous Even for Cash-Strapped Retirees

NEWS & TRENDING - MORTGAGE & LOANS NEWS
Be sure you understand the potential drawbacks of this way to get cash before your enter into a contract.
Updated May 8, 2024
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Reverse mortgages have been marketed as a solution for cash-strapped retirees. In theory, these loans offer a way to tap your home equity without selling the property. You may not want to drain your bank account to pay for home repairs.

However, in some cases, the promise of financial relief may contain major risks and pitfalls that can jeopardize the financial well-being of seniors.

Before considering a reverse mortgage, you need to understand the downsides, not just the benefits touted in ads.

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What is a reverse mortgage?

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A reverse mortgage is a type of loan for homeowners age 62 and older that allows them to borrow against their home equity. 

As the name implies, a reverse mortgage is the opposite of a traditional mortgage, where borrowers make monthly payments to the lender. 

In a reverse mortgage, the lender makes payments to the borrower, either as a lump sum, a line of credit, or monthly payments.

A key feature of a reverse mortgage is that the homeowner doesn’t pay back the loan as long as they live in the home as their primary residence. The loan is repaid when the borrower sells the home, moves out, or passes away. 

At that point, the home is sold to repay the loan, with any remaining equity going to the borrower or their heirs, depending on the terms.

Watch out for scams

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Reverse mortgages are often marketed as a risk-free way to access cash in retirement. While a reverse mortgage is a legitimate financial product, there are many scams that take advantage of seniors in need of money. 

Even licensed lenders may not be upfront about the fees and risks associated with reverse mortgages.

High fees

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Reverse mortgages can have hefty fees. Like traditional mortgages, they include origination fees, closing costs, and mortgage insurance premiums. 

While the borrower may not be required to pay the fees upfront in cash, the fees reduce the amount of equity available in the home. Depending on your home’s value, fees could be several thousand dollars.

You have to worry about more than the loan fees. Like other loans, reverse mortgages accrue interest and fees over time. Over the years, these additional charges add to and compound the loan balance, reducing the equity available in your home.

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Limited access to equity

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Reverse mortgages may only provide borrowers with a percentage of the home’s available equity. Typically, this amount ranges between 40% and 60%. Lenders may also limit the amount available based on the borrower's age at the time of the loan origination.

Older borrowers may benefit from higher loan amounts due to their limited life expectancy. Younger borrowers might receive less due to the increased risk for the lender.

Foreclosure risk

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Unfortunately, there are instances when a reverse mortgage can result in foreclosure. You are still responsible for paying insurance, property taxes, and upkeep on the home when you have a reverse mortgage loan.

The lender is allowing you to borrow against your home with the expectation that the asset will be used to pay back the loan when you move or die. Failure to meet these obligations could lead to foreclosure by your lender.

Impact on government benefits

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While a reverse mortgage doesn’t impact Social Security or Medicare, it can impact other government benefits. 

If you receive a lump sum from your reverse mortgage, it may be counted as an asset, impacting Medicaid or Supplemental Security Income (SSI). You may be ineligible for benefits until you’ve spent some of the money.

Outlive funds

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There are different ways to receive your reverse mortgage funds. You can receive a line of credit, monthly payments, or a lump sum.

If you decide to take the lump sum option, it’s possible you will outlive the funds. In order to access the remaining equity, you would likely need to sell your home or refinance it and pay off the original reverse mortgage.

Inflation risk

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Inflation skyrocketed to 8% in 2022 and is now around 3.5%. Still, that means that your dollar doesn’t go as far and the funds from your reverse mortgage doesn’t hold the same purchasing power as it did before.

Real estate values tend to increase along with inflation, so if you leave the equity in your home, it will grow with inflation. By using a reverse mortgage, you are reducing the equity but also the possible growth of that equity over time.

Loss of homeownership

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With a reverse mortgage, the borrower still remains the homeowner as long as they keep up the terms of the loan, such as continuing to pay property taxes, live in the home, etc.

However, the reverse mortgage is considered a lien on the property. This means if you die, your heirs may forfeit the home unless they pay back the balance on the reverse mortgage.

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Alternate options

Vitalii Vodolazskyi/Adobe Home equity line of credit form

If you’re struggling to make ends meet in retirement, a reverse mortgage can look like a lifeline, but it’s not your only option. Here are other ways to increase your income in retirement.

  • Increase your income: Look for ways to make money working from home to supplement your monthly income.
  • Home Equity Line of Credit (HELOC): This is basically a credit card using your home equity as collateral. It also comes with risks, but it may have reduced fees compared to other loan products. Plus, the interest on the money you borrow may be tax-deductible.
  • Downsize your house: Selling your home gives you access to all your equity. Even if you purchase another home, you may still have some money left over to use toward living expenses.

Bottom Line

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While reverse mortgages may be enticing for some retirees, the risks may not outweigh the benefits. Before considering a reverse mortgage, look for other ways to supplement Social Security or to increase your retirement income.

Homeowners should consult with financial professionals about the impact this move could have on estate planning and your heirs.

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Holly Humbert Holly is a writer who recognizes that there isn't a one-size-fits-all approach to personal finance. She is passionate about entrepreneurship, women in business, and financial literacy. With more than four years of experience, her work has been featured on MarketWatch and The Ways to Wealth.

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