Reverse mortgages--loans that leverage home equity and don't need to be repaid until the homeowner passes away or sells the home--have become popular, but a number of problems with reverse mortgages that should be understood before diving in.
Reverse Mortgages in a Nutshell
Reverse mortgages are generally used by seniors who have financial challenges, but high equity in their homes. This financial vehicle lends against the equity in the home, providing immediate cash to borrowers (usually either monthly or in a lump sum). Meanwhile, the homeowner gets to keep living in his/her home. Sounds like a great deal, right? In some cases, it is, but there are problems with reverse mortgages to be aware of.
Limitations - First of all, not everyone qualifies for a reverse mortgage. Borrowers must be 62 or older, must have at least 30% equity, must live in the house, and must continue to pay off the existing mortgage on the home (if it is not already fully paid off).
Loss of Equity in Your Home - This may be obvious, but it is worth noting that reverse mortgages allow you to access a portion of the equity in your home in the form of cash; therefore, the total equity value of your home is reduced.
Fees - Perhaps the biggest drawback of reverse mortgages is the fees, which can often amount to more than $10,000 up front. These fees are made up of mortgage insurance, origination fees, appraisal expenses, title insurance, escrow, and interest payments. Most of these fees are variable, based on the value of the home, so talk to your financial advisor to get an understanding of your specific fee burden. Remember that this is a loan--not free money--with interest payments on top of the up-front fees.
Counselor Hassles and Cost - The government requires anyone who wants a reverse mortgage to visit with a mortgage counselor first. Uncle Sam's intentions are good; these counselors ensure that seniors understand the ins and outs of reverse mortgages. However, this is an extra step in the process and counselors are not usually free. I definitely consider this to be a problem with reverse mortgages.
Identification - Reverse mortgage borrowers need to have a valid ID, but many seniors who don't drive lack IDs. Without an ID, a lawyer or family member can vouch for the borrower, but this extra step can be a hassle.
Financial Logic - If the senior has significant equity in the house, it might make more sense to simply sell the house and move into another residence. This strategy would avoid the high fees associated with reverse mortgages. While this might make the most financial sense in some cases, it would also defeat the goal of retaining the senior's original house.
I hope this explanation of the problems with reverse mortgages helps you in your decision-making process.