Reverse Mortgage Pros & Cons

Let’s start with the benefits.

The 1st reason most borrowers are attracted to a reverse mortgage, and usually foremost, is that there is no mortgage payment required for the life of the loan.  Payments are allowed, but not required. Think of it as a flexible payment – none, interest only, principal & interest or pay extra principal.

Excluding purchase transactions, the lender can usually pay most, sometimes all, of the closing costs, depending on the amount of the loan at closing.  This is more fully discussed under the section labeled   “No Closing Cost Mortgage: How It Really Works”.

Your home is the only collateral for the loan. If, upon sale, the loan grows to be more the than value of your home, FHA, the government agency insuring the loan, pays the lender for any shortage and there is no adverse repercussions to the borrower.

If the loan is more than the property value when the loan is due, your heirs can purchase the home for  95% of the value and FHA pays the remaining loan balance.

Contrary to what many think, the borrowers maintains title to the property as they would with a traditional mortgage.

If the homeowners are married, only one of the borrowers needs to be 62 years old, although the age of the younger spouse is considered in the maximum loan calculation.

The borrowers can make a monthly payment of any amount they choose. If the mortgage has a credit line, that payment reducing the credit line balance & is available to withdraw again.

A borrower with a credit line can create income tax deductions without actually spending the cash.  This is counterintuitive, but it easy to do with a little instruction.

Most reverse mortgages have a credit line that is available to the borrowers.  The unused portion of any credit line grows at the same rate the borrowers are paying on their loan.  The growth of the line is unrelated to the value of the property.  The unused portion of your credit line will  grow every month even if your property value is static or dropping.  In an extreme situation, your reverse mortgage balance and available credit line can exceed the value of the property.  This is especially true if the borrower obtains the mortgage at or near 62 and stays in the property 20+ years.  As of this writing, an untouched credit line will likely double every 10 to 12 years based modest increase in the unusually low current rates. Few financial & estate planners understand what a powerful tool the credit line can be.

If the total of your mortgage and available credit  line exceed the value of the property, the borrower can  withdraw the balance of the credit line, put the cash in their bank account and then sell the property. The shortfall from the sale is paid by the FHA insurance and your credit is not adversely affected.

 AND THE BAD NEWS. . . .

FHA, which is the type of loan for 99% of reverse mortgages, requires both upfront and annual mortgage insurance.  The annual mortgage insurance is 1.25% for all loans. The upfront mortgage insurance is either .5% or 2.5% of the appraised value, up to a maximum value of $636,150.  Consequently, if the property is appraised at $500,000 and the loan falls into the 2.5% category, the upfront mortgage insurance is $12,500.  This is the component that drives up the total closing costs and compels the borrowers to have the lender pay for some or most of the closing cost if possible.

The maximum value used to calculate the available loan for an FHA insured mortgage is $636,150.  Any value above that is ignored.

Unpaid interest and mortgage insurance is added to your loan balance monthly.

Banks are not legally required to disclose the “rebate”, which is money paid to the loan officer or company by the investor buying the loan.  The investor pays this “rebate” because the borrower is paying a higher interest rate.  This allows the bank to earn an excessive commission without informing the borrower. That inflated rate results in additional interest being added to the loan every month for the life of the loan.

It is unlikely you will be able to borrow on your home after the reverse mortgage is in place.

There is an 18 month waiting period to refinance into another reverse mortgage and it is unlikely it will make economic sense to do so, unless the property value has increased substantially.

Certain events can trigger the loan to become due and payable. Some common examples are: death of the borrowers, vacating the property for 12 months, not paying the property taxes/homeowner’s insurance or not maintaining the property.

The paperwork to complete the mortgage is voluminous and very confusing for almost every borrower. Typically the initial proposal is 100+ pages, the loan application package 300+ pages and the final loan documents 200+ pages.  Included in these pages is educational booklets and duplicate disclosures for the borrower.

A spouse under 62 years old will not be on title to the property, but will have most of the rights of a borrowing spouse, including but not limited to, occupying the property for life.

The recent “financial assessment” guidelines as more fully discussed in the related section, has made it harder to qualify and some credit challenged borrowers will likely have a portion of their available loan “set–aside” to pay taxes and insurance in the future.  This required “life expectancy set–aside” (or “LESA”, pronounced “Lisa”) can prevent a borrower from qualifying for the loan if their equity is not adequate to pay for the existing liens and the LESA.

FHA has minimum property standards related to health and safety concerns.  The borrower may have to do certain mandated repairs prior to close of escrow to qualify for the loan.  The lender allows the cost of such repairs to be paid with loan proceeds at closing if there is adequate equity.  Also, the lender often allows the an amount (usually twice the estimate) to be escrow so the repairs can be completed and paid for after closing.