Are Reverse Mortgages Bad?

Are reverse mortgages bad? Reverse mortgages may be the only choice if you can’t get a cash out refinance or an equity line of credit.

By Ilyce Glink and Samuel J. Tamkin

There are certain real estate topics that seem to generate a fair amount of excitement and interest among our readers. One of those is a reverse mortgage. Our readers ask if reverse mortgages are bad.

Reverse mortgages for those 62 and older

A reverse mortgage is for homeowners aged 62 and older. They can convert their home equity and receive either a single lump sum or regular payments. Or, they can use the proceeds from the reverse mortgage to fix up the property. They can even use them for travel, or even as a supplement to Social Security or other retirement income. Sometimes, a reverse mortgage is used to eliminate a traditional mortgage and free up cash flow for the homeowner.

Unlike a traditional mortgage a reverse mortgage requires no monthly payments. In a traditional loan you make regular monthly payments to pay off the loan over a specific period of time. With a reverse mortgage, the amount due rises over time. You pay off the reverse mortgage when you sell the home or you no longer live in the home full-time.

Our recent article on reverse mortgages certainly got the attention of our readers. We’d like to share some of their comments (which have been edited for clarity and length):

Comment that a cash out refinance is better than a reverse mortgage

Comment: I almost got a reverse mortgage with my wife a few years ago. The thing that stopped us was I had a low credit score. And the amount of money we’d have access to in the line of credit was pitiful. It was also expensive. The only way there would be any house value left after 15 years would be for the market to be on fire. We could literally find no one out of five financially knowledgeable people that would speak positively about reverse mortgages. In some circles, those who get reverse mortgages are considered “poor.”

I think financial advisors who work with clients nearing retirement should strongly encourage them to get a “cash out refinance” before they stop working (and lose the income). This would avoid the pressure to take out a reverse mortgage and leave their clients in a stronger financial position. This is what we ultimately did.

This is a far out idea (for a lot of reasons), but in comparison with getting a reverse mortgage, it may be better to take a job long enough to qualify for “cash out refinance” (if your health allows it).

Comment that ads on TV don’t give enough information

Comment: I looked into a reverse mortgage that I saw advertised on television. I received the CD disk from that company by mail.

The CD disk was all advertising. It had no specifics or details about reverse mortgages, and nothing about financials, dollar loan amounts and costs. I had to call them to get the details. On the telephone, I told them that I wanted a reverse mortgage on my house. My home is worth about $200,000.

I also informed them that I am 68 years old. Told them my FICO credit score is 810, and I fully own the house with no outstanding mortgage. They told me that the maximum loan they give is 50 percent of the value of my house. That would be around $100,000. They also let me know that the cost to get the loan would be about $15,000. Therefore, the net amount I would receive from a $100,000 Reverse Mortgage was $85,000.

Ridiculous reverse mortgage costs

With the higher interest rate and the huge upfront fee, I found their reverse mortgage utterly ridiculous!

A: Well, these two readers haven’t had a good experience with reverse mortgages. As we mentioned in our column, reverse mortgages aren’t for everybody. Indeed, they may only be an option for those who need cash now for some purpose.

There are three types of reverse mortgages: single use, proprietary, and Home Equity Conversion Mortgages (HECM).

Single use reverse mortgages, which are offered by government agencies and nonprofits in some areas, are the least expensive option but use of funds is restricted. Private companies offer proprietary reverse mortgages, which seem to be the options explored by our readers. These are typically more expensive, and the amount you receive is based on a complicated formula that evaluates a variety of factors, including your current home equity and your age (and that of your spouse). And, then there are HECM reverse mortgages. These mortgages are federally-insured and backed by the Department of Housing and Urban Development. They place no limits on what you can do with the funds.

Other options other than a reverse mortgage

As our reader with the $200,000 home noted for working seniors. They might be better off with a cash-out refinance. They might even be better off with a home equity loan or line of credit. On a $100,000 loan from a conventional lender, that reader might spend between $2,000 and $3,000 in closing costs on a cash-out refinance. And, in some situations, the lender might provide for a slightly higher interest rate but lower the closing costs to zero. In the end, if the homeowner qualifies for a $100,000 cash out refinance, that homeowner would end up with $100,000 in the bank, having paid no closing costs.

However, with a conventional mortgage, the homeowner will have to make monthly mortgage payments of principal and interest to the lender for the term of the loan. A reverse mortgage only requires homeowners to pay their real estate property taxes. So, if cash flow is everything, a traditional mortgage may be difficult.

For many older homeowners, their home is their single largest part of their net worth. Leaving an inheritance is an important goal, and often their home is the only asset they can leave to their kids. Getting a reverse mortgage will eat up a substantial portion of home equity, perhaps even all of it depending on how long the owners live after taking out the reverse mortgage.

High upfront costs on a reverse mortgage

As our reader mentioned, he’d end up with $85,000 in cash up front and never have to repay it. But, if he lives long enough, it’s likely that his family would get nothing as the loan would eat up the equity in the home and the reverse mortgage company would sell the home to pay off the debt owed to them.

These are incredibly difficult, expensive decisions to make. Many actors who are familiar, friendly, and perhaps even reassuring, act in reverse mortgage commercials, take your time to fully think through the issues associated with a reverse mortgage before you sign on the dotted line.

©2021 by Ilyce Glink and Samuel J. Tamkin