4 reasons to be wary of a reverse mortgage

House made of coins

Is a reverse mortgage a good way for seniors to improve cash flow or solve other financial problems?

This type of loan allows older homeowners to borrow against their home's equity with no restrictions on how the money gets used and no obligation to pay it back while they're in the home.

Being able to get back the money you’ve paid into your house sounds great, but homeowners should be aware of the risks these loans carry.

There are two primary lines of attack against this type of loan: Seniors aren't using such loans how they were originally intended, and they aren't getting the quality information they need to make a good decision on what's right for them.

Let’s examine four reasons to be wary of reverse mortgages.

Reason 1. They aren't being used as they were intended — to supplement retirement income.

This type of loan was conceived as a way to help borrowers without sufficient retirement income meet their expenses, allowing them "to age in place," the Consumer Financial Protection Bureau wrote in a June 2012 report to Congress.

That's not happening in many cases.

Reverse mortgage rules

Category Restriction
Borrower age Borrower must be at least 62.
Maximum loan 51% to 77% of the appraised home value based on age, type of loan
Mortgage insurance premium Upfront: 2%; ongoing: 1.25% of outstanding loan balance per year.
Source: Consumer Financial Protection Bureau

Instead, many borrowers are using the infusion of cash to pay off their existing mortgage debt. Those considering a reverse mortgage are about 10 percentage points more likely to owe at least a quarter of their home's value than other homeowners their age, the CFPB study found.

Especially for relatively young seniors in their 60s, this poses risks.

"While they gain additional cash flow (that previously was going to mortgage payments) for a period of time, they lose the ability to use their home equity as a cushion against other major expenses in retirement, such as needed home repairs or medical expenses," the CFPB study authors note.

Indeed, borrowers often turn to reverse mortgages because they don't have enough income to pay their home loan, says Jim Pucher, a counselor with HUD-authorized ClearPoint Credit Counseling Solutions based in Richmond, Va.

Using your home's equity in this manner fails to address a fundamental problem: "Some borrowers may simply be prolonging an unsustainable financial situation," the CFPB says.

In this case, downsizing might be the better option, Pucher says. It could result in more manageable upkeep and lower overall costs. If you go this route, you can still take advantage of record-low mortgage rates.

Reason 2. People are tapping too much of their equity up front.

Whether you take out one of these loans to pay off your existing mortgage or other debts, the risk remains the same: You could have too little equity left over to fund your retirement or a down payment if you need to move later.

Or you could simply be digging a bigger hole.

"If they are paying off significant credit card debt but have not changed their behavior, then they may find they simply end up with more debt and no home equity," says Letha Sgritta McDowell, a certified elder law attorney with Oast and Taylor in Virginia Beach, Va.

There are a couple of ways you can get access to the money you're borrowing: a lump sum, in equal monthly payments or in varying amounts on an as-needed basis.

If you opt for equal monthly payments, you know the money will be there as long as you live in the house. Not so when it comes to a lump-sum payment, which is the option most borrowers choose.

Demanding repayment

Reason Explanation
Death The lender may demand the loan be paid off when you or the last co-borrower dies.
Vacancy The loan can be called if you move out of the home permanently.
Extended absence The loan can be called if you don't live in the home for more than a year due to illness or other reasons.
Selling the home The loan can be called if you sell or give the home via a title transfer to someone else.
Neglecting obligations The loan can be called if you fail to pay taxes, insurance or keep the home in good condition.
Source: Consumer Financial Protection Bureau

Reason 3. You could lose your home.

Some sales pitches claim there's no risk you could lose your home. This isn't true.

You must stay current on property taxes, homeowners insurance premiums and property maintenance. Seniors who don't meet these obligations can face foreclosure.

Keep in mind, if you keep on top of these obligations, you should be fine.

What’s more, the most common type of reverse mortgage, the FHA’s Home Equity Conversion Mortgage (HECM), has a built-in system for helping seniors avoid losing their homes for these reasons.

When a borrower falls behind, the FHA requires the mortgage servicer to pay the outstanding charges, then try to bring the borrower current through strategies such as establishing a repayment plan of up to 24 months, connecting the borrower with free financial counseling or even refinancing the loan.

The FHA also has to approve of the servicer's loss mitigation attempts before the servicer can foreclose.

Another problem, and something Pucher says his counseling clients most often have trouble understanding, is that adding a nonborrowing spouse to the title is not the same as adding a spouse to the loan.

If both spouses are not on the loan and the borrowing spouse dies first, the nonborrowing spouse will be required to sell the home or pay off the mortgage debt.

A number of spouses who have outlived their partners have lost their homes as a result.

Reason 4. It's hard to make an informed decision.

These are complex products that offer borrowers a variety of options. Knowing, for example, whether to take out a fixed-rate or adjustable-rate loan, or whether to take your money all at once, aren't obvious choices.

What's more, government agencies are concerned that advertisements for this type of loan have only confused borrowers about the risks, even though applicants are required to attend counseling.

"Counseling may be insufficient to counter the effects of misleading advertising, aggressive sales tactics or questionable business practices," according to the CFPB.

Pucher says the government requires reverse mortgage counselors to follow a specific protocol to identify the client’s needs and circumstances, loan features, borrower responsibilities, fees, financial and tax implications, alternatives, and insurance fraud schemes and elder abuse.

He says counselors also discuss whatever considerations they find appropriate for each client’s unique situation.

But the counseling’s effectiveness depends not only on the quality of the counselor but on logistics.

Pucher says some states require in-person counseling, but borrowers can’t always find an HECM-certified counselor in their communities.

McDowell says telephone counseling is sometimes the only option, because many seniors are homebound and counselors will not go to seniors’ homes. But if the senior has a hard time hearing, phone counseling may not be effective.

She adds that counselors don’t always explain the product well.

Seniors should seek appropriate advice from an attorney or well-qualified financial adviser, McDowell says.

"Without planning, the seniors may find that they are in no better financial position after taking the mortgage than before," she says.

  • Eugene Kishpaugh

    I have a question. How is the loan paid off once both partners pass on? If the house is sold to pay the loan principle and it is worth more than the loan principle who gets the money?

    • Mike Cetera

      Eugene: You can find an answer to your question in this story about dying with a mortgage.

      In short, the house may be sold, and if it's sold and there's equity left, it will go to the heirs.

  • Mario Gutierrez

    My father took a reverse mortgage in 2009 for
    the amount of 197,680. He was 86 years old.
    He was told that this was the best thing in the world. When reviewing his annual statement I
    see that his current principle has increase to
    224,209.71.His finance charge is 1,014.60 every
    month which is added to his principle.
    The total amount due in 11-30-18 will be 358,519. At that time he would either pay that amount or he would have to leave his home. All the money that was paid out to him
    has already been used to pay credit card bills
    and other loans to daughter. He now lives
    with the constant worry that he will be thrown
    out of his home in 5 more years and has no
    other place to live. I as his son will provide for
    him to move in with my family. It is a very sad
    situation for him living this way.

  • Kevin D.

    I used a reverse mortgage to keep my late mother in her home using a credit line option to pay for her in-home care until I reached the limit. I can say that it did improve the quality of her life in that it deferred placement in a managed care environment.

    As heirs you should be aware that monies taken out during a draw down period will be included in the cost basis should you sell the home after your loved one is deceased.

  • Nolan Johnson

    A couple of years ago my mother took a reverse mortgage on her home. We were told that we would be owner of the home after my mother's death. One week after my mother death we recieved a letter from the mortgage company saying that the money obtain had to be paid back in one lump sum.Had my mother known that she never would have gotten the reverse mortgage. She thought that the kids would be able to make monthly payments but they could not. the company wanted the payment in one lump sum. As a result of that we lost our mother's home. No one had that kind of money in one lump sum. If we had there would not have been a need for a reverse mortgage.We were not told the whole story . All that was said is that you keep the house after the death of the owner. Be Very Careful Of What You Sign Or You Too Can Come Up A Looser.

  • Cathy

    This is what I try to explain to people who ask me about reverse mortgages. Those same people don't want to truly hear the answer. It's not a black or white answer! If a 90 year old couple of ill health living in a home fully paid for and needed major maintenance on that home I'd say "get yourself an attorney and call your bank" The attorney is worth every penny to guide you through this major decision. Also, don't call the 1-800 number on TV. Go to your bank!

  • Paul P

    Our company just became approved to do Reverse Mortgages in November of this year. Reverse Mortgages are not for everyone, but they do have safeguards to protect seniors who use them. A Reverse Mortgage is a "no-recourse" loan, which means the borrower will never owe more than the house value or balance of the loan, whichever is less. As long as the senior pays the property tax, home owners insurance and keeps the home in good repair, they can live in the home until they die and never have to pay back any portion of the loan.

  • Janis Pena

    am surviving spouse - there is a R.M on our home--I was removed from deed as I was not 62. Husband has passed, and mortgage servicing bureau had home appraised immediately.
    appraisal came in less than the outstanding loan.
    This is why you pay high mortgage insurance - up front - it guarantees the lender that the loan balance will be paid in full, if the loan exceeds the value. Then I was told I could satisfy the debt by paying 95% of appraised value. I contacted a lending company, and they said, I could refinance the balance of the loan as a reverse mortgage on myself (now 65), as long as I could cover a short fall of 60K. I took 4 months t get this money together. When I was ready ro roll, the new lender said that the existing lender wants to treat it as a 'short sale', and new lender cannot do refi on a short sale...only on a 'short pay' I don't know why they are calling it a 'sale' if HUD says that a surviving spouse can satisfy the debt by paying 95% of the appraised value. It seems to me I am just satisfying the mortgage according to the language that HUD established.

  • Pattie

    My parents got themselves in dire financial straits, and decided to get a reverse mortgage. As the future executor, I asked if I could go with them to ask their financial advisor some questions. Some day, I will have to explain this whole deal to my brothers. Until then, they are unaware. I read all the fine print, and it sounds like they got a better deal than some of the others I see described here. After the second of my parents is gone, everything freezes for 12 months. I was very surprised to learn that "everything" includes interest accrual. We (the estate) will have that 12 months to resolve the loan by 1) paying it off, inlcuding by refinancing if the loan/equity is acceptable at that time; 2) selling it, paying the loan off, and keeping the balance as part of the estate, or 3) walk away and let the reverse mortgage company have it.

    I can live with those options, although at least one brother will be looking for a payday that he has no idea was spent long ago. My only issue is that during this process I learned more about my parents' finances than I ever wanted to. Now, every time they have a significant expense, I am much more aware that they cannot afford it. The thing is, though that they cannot get a "second" on a RM, or at least on the one they got. So the reality is they are limited in the further damage they can do. Creditors who let them overextend at this point do so at their own peril. If needed down the road, I will be able to step in and help with day-to-day expenses.

  • peggy s

    my husband got a reverse mortgage a year before we married. We could have paid it off except this can't be done until the borrower dies.4 weeks after he died a letter came and I quote "dear estate of Mr S. sorry to hear about his death however he had a reverse mortage pay up now either from personal funds,refinance , or sell within 3 mos They hit you when you are vunerable and this is an awful way to steal from seniors.In looking at the orginal paperwork all of the implications are in legalize that even an attorney has trouble with. Luckily I was able to sell and made a small amount over the amount owed which was 3 times what he borrowed. But in the meantime they
    threatened to foreclose 3 times and phone calls came daily.NEVER USE A REVERSE MORTAGE. Fred Thompson and others who adverise this should have to pay every reverse mortage out there. They are lying thru their teeth

  • Sheila

    I'm 62 and divorced the house has been for sale since march. My Ex only has to pay mortage til Feb. I'm on disabilty and can"t afford the mortage. would a reverse mortage be advisable for me?

  • Carole

    With the interest rates so low, can you refinance a reverse mortage and if so, is it recommended?

  • lorenzo moreno

    I believe that this type of lending is predatory and those responsible for providing this type of loan should be held accountable. It's great for those seniors who have no one to leave the property to after death, but for those who wish to leave the property to family is a big mistake. Seniors would be better off taking out a personal loan on the equity of the home than taking one of these crazy rip offs of our senior citizens.

  • http://graham-financial.com Trish Graham

    As a financial advisor, I occasionally recommend a reverse mortgage to my clients. I generally require that an adult child that they have confidence in be present to help them in their decision. I don't recommend them to younger clients who don't have financial discipline. I do suggest them to older clients whose medical or maintenance needs exceed their ability to pay.
    Often older people drive the decision because they don't want to move. Senior and low income housing is a real alternative as most of it is income based rather than asset based. The cost of keeping people in their own home can well exceed the cost of a moderate senior living facility. Weigh both before making the decision.

  • Sharon

    It's important to understand that a reverse mortgage is a financial product and, like ALL financial products, it's not for everyone. Education, information, and responsible lending are key.

    It's essential to make an informed decision--especially when it involves your home--and mortgage professionals have the responsibility of taking the time to listen to their clients, understand their needs, and advise them accordingly. It means having to say "no" sometimes or point the client in a different direction. When it's the right program for the right client in the right situation, it makes sense.*

    Our company does reverse mortgages (as well as forward mortgages) and we have our own very stringent requirements on who in the company can do them. (Education, experience, commitment, and even a closely supervised probationary period are involved.) We also encourage clients to include their family in the decision and to seek additional advice and recommendations from other trusted professionals in their lives (attorneys, financial advisors, etc.). And we're not afraid to discourage someone from choosing one--even if they qualify--if it's not the best decision for them.

    There is no free money to be had. All mortgages are expensive. Homeowners have to be sure that they understand the terms of the loan and the impact it can have on a surviving spouse who isn't on the mortgage, have to understand their responsibility to pay taxes and insurance, and have to be shown all of their options.

    If you or a loved one is considering a reverse mortgage, seek out recommendations for responsible mortgage professionals. Find someone who will ask a lot of questions, who will listen to your needs, and who will take the time to explain all of your options and what makes sense for you. And remember--it's never a "no-brainer."

    * Same thing went for option ARMS, by the way. They were excellent for financially savvy people who were excellent at managing their finances AND who had the money to pay them back. This was a very SMALL segment of the population and irresponsible lending led to a lot of bad decisions.