What are the risks of getting a reverse mortgage?
Reverse mortgages have many rules and complexities. Not understanding all the nuances makes them a risky venture for some seniors.
A federally insured Home Equity Conversion Mortgage (HECM) removes much of the risk of reverse mortgage, because of the added insurance provided by the Federal Housing Administration (FHA) and the specific consumer protections provided by the program.
Rule changes over the years have also minimized reverse mortgage risks. For example, borrowers are limited on how much of their principal limit they can access upfront. There have also been recent changes that allow spouses to remain in the home after a borrower has passed away if the surviving spouse was not included on the original loan.
Even with these protections, there are several reverse mortgage risks. Below are three of the most common:
Inflation risk of reverse mortgages
Reverse mortgage payouts and lines of credit typically do not adjust for inflation. If you choose a tenure payment, you will receive the same monthly amount for as long as you keep the loan open. Likewise, if you opt for a line of credit, the amount available won’t change for the life of the loan.
In the meantime, there’s a good chance that the cost of basic needs and services will increase over time, as well as other costs like property taxes and health care.
If your reverse mortgage payout barely covers your expenses when you first obtain it, chances are it may not meet your needs 10 or more years later without finding supplemental income sources.
The good news is that if your home’s value also appreciates during the life of your reverse mortgage, you may be able to refinance it down the road and obtain a larger principal amount. This could provide a higher monthly tenure payment or line of credit.
Default risk of reverse mortgages
When a reverse mortgage ends the way it’s designed, loan repayment is due when the homeowner(s) no longer need the house in which they’re living. Typically that occurs when the borrower(s) dies or wants to move out of the home for a variety of reasons.
Since there are no monthly payments to make, reverse mortgage borrowers cannot default on the loan itself. But they can put themselves in a foreclosure situation if they do not pay property taxes, homeowners insurance, or utilities, or they don’t maintain the property to proper standards. All reverse mortgages require the homeowner to stay current on these expenses.
Defaulting on a reverse mortgage because you’re unable to stay current on taxes and insurance is a tangible risk for seniors who have limited sources of income. If you find yourself in a default situation, about the only way to avoid foreclosure is to pay up your taxes or insurance, or fix whatever is causing the loan to be in default.
If you have money in savings or retirement accounts, valuables you can liquidate, or resources you can borrow from family members, you can use those assets to bring your loan back into good standing. You can also sell the home and use the proceeds to repay the loan.
Otherwise, the reverse mortgage lender will foreclose on the home, and the homeowner(s) will have to vacate the property.
Health risk of reverse mortgages
A stipulation for all reverse mortgages is that the borrower continue living in the home. Moving out for any reason results in the loan being called, and repayment being due.
This include situations in which the homeowner’s health results in a need to move into an assisted living facility or nursing home.
If a health incident occurred shortly after obtaining the reverse mortgage, it’s possible the borrower will have spent $10,000 or more on fees and closing costs without receiving much income from the loan itself.
In addition, the payments on the reverse mortgagee will stop once the homeowner moves out, but interest and fees will continue to accrue until the loan is fully repaid. In these situations, that usually means having to sell the home to repay the loan, which can take several months.
Another health-related reverse mortgage risk is a situation where only one spouse was included on the loan because the other individual had not reached age 62 at the time of the loan.
Non-borrower spouses can remain in the home after the borrowing spouse has died, however, they will not have access to any remaining loan funds. If the reverse mortgage provided monthly payments, those payments will cease once the borrower has died. If a reverse mortgage line of credit was established, the non-borrowing spouse will not have access to those funds after the borrower has died. At the same time, interest will continue to accrue on the unpaid balance until the loan is repaid.