Pros and Cons of Reverse Mortgages

With a regular mortgage, the borrower gets a loan from a lender and pays it back over time. Each payment you make builds equity in the mortgaged property, and the loan balance decreases. In a reverse mortgage, you borrow money using your home to secure the loan, like a regular mortgage. But instead of getting an upfront lump sum that has to be steadily paid back, you get payments from the lender, which become the loan.

Most reverse mortgages are Home Equity Conversion Mortgages (HECMs), which the U.S. government insures through the Federal Housing Administration (FHA). (FHA is a part of the U.S. Department of Housing and Urban Development or "HUD.") But the insurance mostly benefits the lender, not the borrower; if the loan is accelerated and the house isn't worth enough to pay back the lender in full through a foreclosure sale or another liquidation process, the FHA compensates the lender for the loss.

This article covers the typical pros and cons of HECM reverse mortgages, though non-HECM reverse mortgages have similar upsides and downsides. Consider all your options before getting a reverse mortgage because a better alternative could be available.

Why Are Reverse Mortgages Usually a Bad Idea?

Reverse mortgages are sometimes beneficial for homeowners who lack money to meet their daily needs and have a valuable home. But for most people, getting a reverse mortgage is a bad idea; the list of cons exceeds the pros. For instance:

• Your loan gets bigger over time. Unlike regular mortgages, the loan balance on a reverse mortgage goes up the longer you have it.
• As your loan balance grows, your equity in your home shrinks.
• These loans can be expensive.
• Reverse mortgage lenders can (and do) foreclose.
• A reverse mortgage could affect your eligibility for need-based government programs like Medicaid.

Pros of Getting a Reverse Mortgage

Again, reverse mortgages offer some advantages. If you have a lot of equity in your home but are cash-poor, a reverse mortgage might be a reasonable way to get extra spending money to meet your everyday needs.

Other upsides to reverse mortgages include the following.

1. HECMs Are Nonrecourse Loans

The loan is nonrecourse if the lender accelerates a HECM and forecloses the home. So, the lender can't seek a deficiency judgment against you (the borrower) or your estate.

Other kinds of reverse mortgages are sometimes nonrecourse, but not always.

2. You Don't Have to Make Monthly Payments on a Reverse Mortgage

Unlike with a regular mortgage, as long as you live in the home and don't breach the terms of the reverse mortgage agreement, you don't have to make any payments on the loan until it comes due (see below).

3. A Reverse Mortgage Might Be Able to Stop a Foreclosure

If you're behind on payments on a regular mortgage and facing an impending foreclosure, getting a reverse mortgage to pay off the existing mortgage could be an option for saving your home. After taking the loan proceeds from a reverse mortgage, typically a lump sum, and paying off the existing loan, the foreclosure will stop.

Unlike refinancing your mortgage loan, reverse mortgages don't have a minimum credit score or income requirements. Eligibility to get a reverse mortgage is based mainly on your equity in your home, along with a few other factors, like your age. So, even if you're in foreclosure and your credit has taken a hit, you still might be able to get a reverse mortgage.

Still, you don't get a complete pass regarding your credit history and getting a reverse mortgage. You'll still have to show that you have the financial ability to maintain your home and continue paying property taxes and homeowners' insurance. If the lender determines that you probably won't be able to keep up with paying for these items, it will create a set-aside account as part of the reverse mortgage.

And reverse mortgages can be foreclosed in several circumstances (see below).

Cons of Taking Out a Reverse Mortgage

While reverse mortgages have some benefits, these loans also have significant downsides.

1. Your Loan Gets Bigger Over Time

With a reverse mortgage, like a regular mortgage, you'll owe the money you borrow, plus interest and fees. However, unlike traditional mortgages, the amount you owe on a reverse mortgage increases over time.

Here's why: With a HECM, the lender provides the borrower with a lump sum, periodic payments, or a line of credit to draw upon (or a combination of monthly payments and a line of credit). The loan amount grows every time the lender sends a payment or the borrower makes a draw until the maximum loan amount has been reached. The payments the borrower receives, along with accrued interest and fees, increase the loan balance. So, the outstanding amount you owe goes up—not down—over time.

Also, ongoing interest and fees, like mortgage insurance premiums (MIP) and servicing fees, get added to the loan balance each month, and these costs compound. So, every month, you're charged interest and fees on the interest and fees that were tacked onto your loan balance the previous month.

2. As the Loan Gets Bigger, Your Equity Gets Smaller

The bigger your loan balance on a reverse mortgage, the less equity you have in the home. So, you'll lose some (or all) of the equity you've built up over the years with a reverse mortgage.

If you plan to eventually sell your home to pay for things like long-term health care costs or to finance a move elsewhere, or you plan to leave the property to your heirs, you might not have any equity left then.

If you plan to leave your home to heirs, they'll need to understand their repayment options. To keep the property, they'll have to repay the total loan balance or 95% of the home's appraised value, whichever is less. FHA insurance pays the remaining balance.

3. Reverse Mortgage Lenders Can Be Quick to Foreclose

Reverse mortgage lenders rarely hesitate to foreclose if a loan isn't repaid once it comes due.

With a HECM, when one of the following events happens, the lender can accelerate the loan:

• You (the borrower) permanently move out of the home, and the property is not the principal residence of at least one other borrower. Even if you still own the property, the lender can call the loan due if you live elsewhere most of the time (and your principal place of residence changes).
• You die, and the property is not the principal residence of at least one surviving borrower. A nonborrowing spouse might be able to stay in the property even after the borrower has died if specific criteria are met.
• You move out of the home because of a physical or mental illness and are absent for over 12 consecutive months, and the property is not the principal residence of at least one other borrower. So, if you move into a care facility, like a nursing home, the lender can call the loan due after you've been gone from the home for over a year. (Though Mortgagee Letter 2021-11, which provides guidelines for HECM lenders, says that some nonborrowing spouses of reverse mortgage borrowers can remain in the property after the borrower moves into a long-term care or another healthcare facility.)
• You sell the home or transfer title (the home's ownership) to someone else, and no other borrower retains title or a specific kind of leasehold in the property.
• You fail to comply with the mortgage requirements like staying current on property taxes, keeping homeowners' insurance on the property, and keeping the home in a reasonable condition.

The lender can accelerate the loan in any of the above-described scenarios. The lender will foreclose if you or your heirs don't do one of the following.

• Repay the loan in full or pay 95% of the property's current appraised value, whichever is less. (Remember, FHA insurance covers any shortfall.)
• Give the property to the lender in a deed in lieu of foreclosure.
• Sell the property for the lesser of the loan balance or 95% of the appraised value. Again, FHA insurance covers the remaining balance.

Reverse mortgages are set up so that the lender will get its money back or end up owning the home. Even if you comply with all parts of the mortgage contract, it's likely you won't have much money or equity left when the loan is due, and you'll likely lose the property.

4. A Few More Downsides to Reverse Mortgages

But that's not all. A reverse mortgage could affect your Medicaid eligibility or eligibility for other government need-based programs. Talking to a benefits specialist before getting a reverse mortgage is a good idea.

Also, reverse mortgages are expensive. Their fees are often higher than a regular mortgage.

Furthermore, shady mortgage brokers sometimes try to convince older homeowners to get a reverse mortgage by making misleading claims or misrepresenting the terms of the agreement. For example, some reverse mortgage advertisements say you'll get "tax-free money" if you take out this kind of loan. But reverse mortgage payments are considered loan proceeds, not income. So, of course, reverse mortgage proceeds aren't taxed.

Alternatives to Reverse Mortgages

Because a reverse mortgage provides money that you don't have to pay it back until much later (in theory), a reverse mortgage might come across as pretty tempting.

But considering all the drawbacks, it's usually best to look into other options if you need money. For instance, you could consider:

• Selling your home and downsizing to a more affordable place to live.
• Getting a regular mortgage or refinancing your traditional mortgage to lower the payments. However, you need to pay close attention to your new mortgage's term (length) because it could affect your long-term plans. For example, getting a new 30-year mortgage could cause financial issues later. So, consider getting a mortgage with a shorter term, like ten or 15 years. And be aware that qualifying for a new mortgage or refinance depends on your income and credit.
• Taking out a home equity loan. Though, these loans also carry risks. Qualifying for a home equity loan also depends on your income and credit.
• Applying for a federal, state, or local program that provides grant money or other financial assistance to seniors, like a single-purpose reverse mortgage. Some state and local government agencies, as well as non-profit organizations, offer these loans. If you qualify, these programs are a much better option than getting another type of reverse mortgage.
• Looking into whether you qualify for a property tax credit or abatement (reduction). Many places provide tax relief options and other forms of financial relief for older homeowners.

And if you're still thinking about getting a reverse mortgage after considering all of the downsides, you could wait until later on to get one. By taking out a reverse mortgage when you're older, you could potentially still get money from the loan when you have higher costs, like rising health care costs.

How to Get More Information About Reverse Mortgages

Before you can get a HECM, you must talk to a housing counselor from an independent government-approved housing counseling agency. Go to the HUD website for a list of counselors, or call HUD at 800-569-4287 to learn more about how HECMs work. You can talk to a counselor even if you're just thinking about getting a reverse mortgage.

Also, because reverse mortgages are so complicated and have serious consequences, consider talking to an elder law or consumer protection attorney, or a financial advisor. If you're concerned about a reverse mortgage foreclosure, talk to a foreclosure lawyer in your state.

To get more general information about the pros and cons of reverse mortgages, visit the AARP website. The Consumer Financial Protection Bureau offers a helpful reverse mortgage discussion guide and advises consumers considering taking out a reverse mortgage to consider all other alternatives. The Federal Trade Commission (FTC) website also provides information for homeowners considering taking out a reverse mortgage.