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.
Reverse mortgages are sometimes beneficial for homeowners that 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:
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.
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.
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).
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).
While reverse mortgages have some benefits, these loans also have significant downsides.
With a reverse mortgage, like a regular mortgage, you'll owe the money you borrow, plus interest and fees. But different from 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 on to your loan balance the previous month.
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.
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:
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.
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.
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.
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:
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.
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 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.