Pros and Cons of Reverse Mortgages

Financial Planning Association

If you're at least 62 years old and the owner of a home that has significant equity, you have an opportunity to turn that equity into tax-free cash without having to move or make a monthly payment. It's called a reverse mortgage and can be a great financial tool — if you make sure it's truly right for you.

A reverse mortgage gets its name because it is the reverse of a traditional mortgage. Instead of the borrower making payments to the lender, the lender makes payments to the borrower, building the owner's debt level in the property as time goes on. The borrower gets to stay in the house and doesn't have to pay back the money as long as he or she continues to live in the home. When the owner dies or moves away, the house can be sold, the loan paid off and any leftover money goes to the living owner or the designated heirs. Yet it is not absolutely necessary that heirs have to sell the house — they can either pay off the reverse mortgage through their own funds or a refinance as long as they do it within a year of inheritance.

There are three basic types of reverse mortgages. The first are single-purpose reverse mortgages, which are offered by some state and local government agencies and nonprofit organizations; next are federally-insured reverse mortgages, which are known as Home Equity Conversion Mortgages (HECMs), and are backed by the U. S. Department of Housing and Urban Development (HUD); and finally proprietary reverse mortgages, which are private loans that are issued by the companies that develop them.

Borrowers may receive the money from a reverse mortgage in three ways:

  • A lump sum cash payment;
  • A monthly cash payment;
  • A line of credit;
  • Some combination of the above.

Reverse mortgages have traditionally been chosen by older Americans who can't cover a major medical bill or who otherwise have a need for cash for such things as long-term care premiums, home healthcare services or domestic help. More recently, though, they've become popular with individuals who see them as a better alternative to home equity lines for a variety of purposes from funding travel to financing second homes.

It's a good idea to consult with your financial adviser before you make this decision. These loans can be very complex. You may be required to meet with a counselor before you can apply, and this may delay closing on this type of financial arrangement for two to three months.

There are several potential drawbacks to reverse mortgages that need to be considered:

They're expensive: Reverse mortgages are generally more expensive than traditional mortgages in terms of origination fees, closing costs and other charges. For instance, a $200,000 reverse mortgage may cost as much as $10,000 in various fees. Private lenders are generally the most expensive, and some may charge ongoing fees for the life of the mortgage. You'll need to shop several lenders to compare, and focus on total annual loan cost.

You'll still need to watch interest rates: Reverse mortgages have rates that are typically higher than those charged on conventional mortgages. Interest is charged on the outstanding balance and added to the amount you owe each month. Again, check the total annual loan cost.

You'll need to make sure you're not endangering your federal retirement benefits: If your total liquid assets exceed allowable limits under federal guidelines, you might endanger your benefits. Make sure the monthly amount of your cash advance doesn't leave you with too much cash after your bills are paid.

Your mortgage can be called: If you fail to pay your property taxes, fail to adequately maintain your home or pay your insurance premiums, the lender can declare the mortgage due or reduce the amount of monthly cash advances to pay those overdue amounts.

You may not leave much to the kids: If your house is your major asset, getting involved in a reverse mortgage may not leave much to the next generation - if it appreciates, there may be some difference that the kids can have. That's why that in addition to discussing a reverse mortgage with a financial adviser, senior citizens really need to talk about it with their families.


May 2006 — This column is produced by the Financial Planning Association® (FPA®), the leadership and advocacy organization connecting those who provide, support and benefit from professional financial planning. Please credit FPA and provide a link to FPA at if you use all or part of this column.

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