The Disadvantages of Reverse Mortgages

My aunt took out a reverse mortgage back when they were a brand-new financial product per my advice. I've learned a lot about them since then. 

A reverse mortgage allows a homeowner 62 or older to borrow against the home's equity. This type of arrangement can be an attractive option for a retired person who has lots of equity built up in a home but doesn't have enough money to afford daily living expenses, as was the case with my aunt. I suggested she take out a reverse mortgage in the early 1990s, before I knew much about them. Although it was probably the right choice for her, I have since learned of the various disadvantages that exist.

They're Complicated

A reverse mortgage is a type of loan, and a complicated one at that. The principal and interest must be paid off at some point -- when the borrower moves, sells the house or passes away. This amount could be quite large since the borrower doesn't pay the loan back monthly. The amount owed keeps increasing, and interest continues to build. The process to determine how much a person can borrow is also complicated; it's based on a percentage of the home's worth, its location and, in the case of co-owners, the age of the youngest borrower.

Source: morgueFile

They're Expensive

Reverse mortgages are expensive when you consider the origination fees and closing costs. Servicing fees also occur throughout a mortgage's term. Because of the high costs, it's a bad idea for borrowers to take out reverse mortgages if they intend to leave their homes in fewer than five years. My aunt had no plans to move, so no worries there. But if health reasons require borrowers to live in medical facilities or nursing homes for 12 consecutive months, the loans become due. This did happen to my aunt but only after she had the reverse mortgage for about 15 years. Which brings me to another disadvantage: keeping these loans out for a long time isn't a great option. The longer borrowers have reverse mortgages the bigger the loans grow because of compounding interest.

Monthly Insurance Premiums

Most reverse mortgages are offered through the U.S. Department of Housing and Urban Development's Federal Housing Administration. All people who take out an FHA-insured reverse mortgage must pay a monthly insurance premium. These fees need to be paid upfront or they'll be added to the reverse mortgage. The latter incurs interest charges.

Less to Leave to Heirs

A reverse mortgage can easily eat all the equity left in the home. My aunt wanted to leave the house to my cousin, but she needed to pay off the loan in full to keep it. The loan was not more than the property's value, but if it were, my cousin would have had to pay a loan larger than the home's value. If she had chosen to sell the house, however, the debt would not have been more than what the house sold for because the loan was from the FHA. A non-FHA loan from a private company, a nonprofit organization or a state or local government might not have the same guarantees or protections.

A Bad Option

Reverse mortgages might be a worse option compared to other choices. A home equity loan, a home equity line of credit and loans made by state and local governments to pay for items such as home repairs and property taxes aren't as expensive as reverse mortgages. They require monthly payments, so they work only if borrowers can afford to make them.