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Are Reverse Mortgages Good for Retirement Income?

You may have heard of a reverse mortgage or seen advertisements about the benefits of a reverse mortgage.  Basically a reverse mortgage is a loan on the equity of your house.  Reverse mortgages are clearly not meant for wealth building or asset protection and should not be considered a wise investment strategy.  Think of a reverse mortgage like a pawn shop for your home’s equity and the pawn shop allows you to continue living in your house.  In order to get the equity back you would have to pay the pawn shop the money that you borrowed plus interest and fees.

For some background, from the U.S. Department of Housing and Urban Development Frequently Asked Questions about HUD’s Reverse Mortgages:

What is a reverse mortgage?

A reverse mortgage is a special type of home loan that lets you convert a portion of the equity in your home into cash. The equity that you built up over years of making mortgage payments can be paid to you.  However, unlike a traditional home equity loan or second mortgage, HECM borrowers do not have to repay the HECM loan until the borrowers no longer use the home as their principal residence or fail to meet the obligations of the mortgage.

* HECM is Home Equity Conversion Mortgage

Can I qualify for FHA’s HECM reverse mortgage?

To be eligible for a FHA HECM, the FHA requires that you be a homeowner 62 years of age or older, own your home outright, or have a low mortgage balance that can be paid off at closing with proceeds from the reverse loan, and you must live in the home. You are also required to receive consumer information free or at very low cost from a HECM counselor prior to obtaining the loan.

What are the differences between a reverse mortgage and a home equity loan?

With a second mortgage, or a home equity line of credit, borrowers must have adequate   income to qualify for the loan, and they make monthly payments on the principal and interest.  A reverse mortgage is different, because it pays you – there are no monthly principal and interest payments.  With a reverse mortgage, you are required to pay real estate taxes, utilities, and hazard and flood insurance premiums.

Will we have an estate that we can leave to heirs?

When the home is sold or no longer used as a primary residence, the cash, interest, and other HECM finance charges must be repaid.  All proceeds beyond the amount owed belong to your spouse or estate.  This means any remaining equity can be transferred to heirs.  No debt is passed along to the estate or heirs.

This is somewhat misleading because if the loan amount exceeds the value of the home the difference will pass to your heirs.

What if I change my mind and no longer want the loan after I go to closing?  How do I do this?

By law, you have three calendar days to change your mind and cancel the loan.  This is called a three day right of rescission.  The process of canceling the loan should be explained at loan closing.  Be sure to ask the lender for instructions on this process.  Mortgage lenders differ in the process of canceling a loan.  You should ask for the names of the appropriate people, phone numbers, fax numbers, addresses, or written instructions on whatever process the company has in place.  In most cases, the right of rescission will not be applicable to HECM for purchase transactions.

If you have entered a reverse mortgage without talking to a financial advisor, we strongly recommend you invoke the three day right of rescission and talk to a professional that can analyze your situation and determine your best options.  Reverse mortgages should only be used in extreme situations where there are no other options for cash flow for living and / or medical expenses.

Consumer Reports puts it bluntly:

“Reverse mortgage should only be a last resort for seniors who want to stay in their homes and have no other alternatives.”

From Clark Howard – Pros and Cons of a Reverse Mortgages for Seniors:

“A reverse mortgage should be the last option, not the first, when all else has been exhausted. If you’re talking about a family with younger members of means, it is generally better to have them financially help out aging relative than to have a broker or salesperson take advantage of the senior with a reverse mortgage.”

As mentioned above the fees paid are in addition the interest that accrues over the life of the loan.  It should be noted that the homeowner continues to pay all property taxes, insurance and home maintenance expenses.

The fees can include the following:

  1. Mortgage Insurance Premium
  2. Loan Origination Fee
  3. Closing Costs
  4. Mandatory Credit Counseling

In conclusion, you cannot say that reverse mortgages are always a poor choice but if there are other options for cash flow during retirement, you are better off with those other options.


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