by Nancy Osborne, COO of ERATE®
(5/17/2013) For those aged 62 and older, a reverse mortgage can work somewhat like an annuity, providing payments from the lender to the homeowner, while permitting them to remain living in the home. However the loan balance increases, rather than decreases, over time and must be repaid to the lender when the homeowner moves or passes away. A reverse mortgage is not the best option for all eligible homeowners and can back fire on those who are not aware of its terms and conditions. Here are a few drawbacks anyone considering a reverse mortgage should consider:
It's Not Cheap
Anytime a lender gives you money, you know it's going to cost you, even when the lender is tapping into your equity and returning it to you. Reverse mortgage origination fees can include up to 2 points or 2% (on a $200,000 loan that would be $4000) up to a maximum of $6,000. Other traditional mortgage fees apply as well including: appraisal (to be completed only by an FHA approved appraiser), credit report, title fees and a flood cert. However the biggest fee associated with a reverse mortgage is the 2% mortgage insurance premium (MIP) which the government insurer of these loans, the Federal Housing Administration (FHA) requires. This amount is based upon the appraised value of the home and not the loan amount itself. So for a home valued at $400,000, the MIP would be $8,000 and is required to be collected upfront. Some of the fees can be ongoing in nature and may be collected a monthly such as a nominal service fee. Given that the fees associated with originating the loan are so high, it is wise to only consider this as a long term solution to a cash flow problem and not a medium or short term fix because a homeowner could end up draining a lot of their equity unnecessarily on all the upfront costs.
Beware of Biased Advice
Commission structures have incentivized loan brokers to persuade homeowners to take the lump-sum reverse mortgage with a fixed rate, instead of the more flexible line of credit which is tied to an adjustable rate, because the interest expense on the lump-sum loan accumulates monthly and can grow to a point of far exceeding the initial loan amount. Fortunately this bias was effectively eliminated by removing the fixed rate option on these loans. Another problem which has emerged, are reported cases of homeowners being persuaded by their loan brokers to consider having the older of two spouses become the sole applicant on the mortgage application. Loan brokers can receive bigger commissions when they originate higher loan amounts with the older spouse as the sole applicant. Some homeowners who elected to take this advice intended to add the younger non-applicant spouse back on title at a later time but neglected to do so resulting in serious complications should something happen to the older spouse who effectively is the sole property owner. The younger spouse who is not on title could find themselves in the unhappy position of being forced to move from the home should the older spouse, who is solely on title, pass.
Failure on the part of the homeowner to pay all property taxes and hazard insurance could be sufficient cause for the loan to be called for immediate repayment by the lender. Repayment of a reverse mortgage is also required if the home remains unoccupied for a specified period of time. For instance should a homeowner require lengthy hospitalization or a long stay in a nursing home, leaving the home vacant for some time, could trigger an immediate repayment requirement on the reverse mortgage.
Detracts from Medicaid Benefits
Eligibility for Medicaid is strict with respect to liquid assets which are limited to $2,000 per individual and $3,000 per couple. If funds are received from a reverse mortgage which causes the senior homeowner to exceed these limits, then Medicaid eligibility could be in jeopardy. Some advisors recommend spending all funds realized from a reverse mortgage as soon as they are received. Seniors need to be aware of this potential problem and do all they can to insure it is not an issue for them.
Impact on Future Financing Needs
A reverse mortgage creates a liability which must be repaid. This liability or debt may limit the homeowner's ability to borrower for any reason in the future as it will impact total indebtedness. This can affect applications for auto and credit card loans. Many reverse mortgage applicants are not in a stage of life where credit purchases are commonplace but this is still a consideration for some.
Typically, the loan is repaid in full at the time of the homeowners passing by selling the property with any remaining proceeds, net of the reverse mortgage balance, going to the heirs of the homeowner's estate. Life insurance can be an effective workaround for those wanting to leave all the equity in their home to their heirs. However this requires careful planning because life insurance can be expensive and difficult to obtain after a certain age. Seniors who plan far in advance may have a life insurance policy in place which would cover the balance accumulated on the reverse mortgage at the time of their passing.
Other related articles: