A few weeks ago, I posted an article on the benefits of reverse mortgages, and they are substantial.
Eliminating your monthly mortgage payment should substantially improve you cash flow. Having the ability to easily access the previously untouchable equity in your property should provide quite a bit more flexibility in dealing with significant expenditures.
But there are some downsides to these mortgages as well.
One of the biggest is that you must have more that 50% equity in your property and more is better. These mortgages are generally targeted at folks who have had their properties for a long time and have built up quite a bit of equity but that equity is difficult to access without either refinancing or selling the property. Ther first of these options can be expensive and would do little to improve monthly cash flow. The second might not be an option since a new place to live would have to be found and there may be some long-term family issues that arise.
So, with all those benefits what is on the other side of the ledger.
High Fees and Costs:
As with all mortgages there are significant upfront costs including a potential appraisal, origination fees, mortgage
insurance premiums, and closing costs. These are all included in determining the among of funds that can be distributed.
One of the charges that make no sense to me is the need for mortgage insurance which explained away be stating that this is a FHA requirement. But what is being insured? There is more than a 50% equity in the property which the bank controls, so their risk is quite low. But they collect hundreds of dollars per month for this.
Complicated Terms and Conditions:
Reverse mortgages can be complex, with various terms and conditions that may be difficult to understand. Misunderstanding these terms can lead to unexpected financial obligations or penalties. As an example, the availability of an easy access line of credit is touted as a great benefit and if you have a great deal of equity it would be. But what is typically not made clear is that money withdrawn with the line of credit is added to the total loan. With a typical line of credit loan from a bank, you would be required to make regular payments to decrease the balance. Using the reverse line of credit, the principal and interest due monthly are added to be overall principal.
One other item that bears watching is the interest rate. It was my understanding that the interest rate was fixed a the time of the contract but it is not. The interest rate is variable and adjusts month to month. In addition, the bank adds a margin fee to the interest.
Reduction in Home Equity:
What is not typically understood is the reverse mortgage is really just a mortgage with month principal and interest payments. In the reverse case, however, you are not making these monthly payments. As you progress through the reverse mortgage, these and all of the fees are added to your loan balance. Thus, the loan balance increases over time. As a result, the homeowner’s equity in the property decreases. This can leave less equity for heirs or for the homeowner to access in the future.
The hope of course is that property values will also increase and hopefully at a rate that is greater than monthly cost additions to the loan.
Impact on Benefits:
Receiving reverse mortgage proceeds can affect eligibility for need-based government programs like Medicaid and Supplemental Security Income (SSI). It’s important to understand how these funds may impact such benefits.
Risk of Foreclosure:
From a property owner’s perspective, not a lot changes. Borrowers must continue to meet certain obligations, such as paying property taxes, homeowner’s insurance, and maintaining the home. The difference is that these expenses cannot be included in an escrow account which paid along with the normal monthly mortgage payment. Failing to meet these requirements can result in foreclosure and the loss of the home.
Also, it the line of credit is utilized to a great extent and there happened to be an associated significant drop in home values (e.g. 2009), then the debt-to-equity relationship could become unfavorable from the banks perspective and that could call the loan. But as stated above and as the experience of the last couple of decades has shown, home values are expected to continue to grow.
As a quick summary, reverse mortgages are a great option for some property owners and provide significant cash flow gains and access to trapped capital equity in real estate. But as with all financial transactions it is imperative to know as much as you can about them and to uncover all of the unintended consequences that could occur.
Banks play the long game! They give up monthly income from a typical mortgage and replace it with long term payback years from now. But in the meantime they charge us a lot for this deferred payment.
I am pretty happy with my experience but still complain about the mortgage insurance, variable interest and miscellaneous charges that get added to my balance each month.
