The downside of reverse mortgages

With no monthly payments and the ability to let the estate settle the loan, reverse mortgages are a pretty appealing financial tool. Especially for retirees looking to chip away at high-interest debt, make age-in-place renovations, or boost their cash flow during their golden years. 

While this can be an attractive offer and strategic path for some, it’s essential to understand the impact on your finances before signing on the dotted line.

This guide will explore the downsides of reverse mortgages and help you understand when they make sense. 

How reverse mortgages work

With a reverse mortgage, homeowners 62 and older can borrow against their equity for a lump sum, monthly payout, or line of credit. Unlike a traditional mortgage, where borrowers make monthly payments, a reverse mortgage provides payments to the homeowner. 

Interest accrues over the life of the loan and is settled with the loan balance when the homeowner moves out, sells the home, or passes away. 

To qualify, individuals must:

• Be 62 or older
• Live in the home and keep it as their primary residence
• Have enough income to cover home repairs, insurance, and property taxes
• Own their property or most of the equity outright

The downside of reverse mortgages

Reverse mortgages aren’t free (or cheap)

Reverse mortgages are some of the most expensive loans on the market. You'll have upfront costs, like origination fees, closing costs, mortgage insurance premiums, and servicing fees, which skew higher than other loans. Interest rates also tend to be less favorable than other equity tools, which means the loan balance grows faster over time.

There are strict conditions over the life of the loan

To keep the loan in good standing, you'll have to comply with various conditions. You'll be expected to:

• Live in the home as your primary residence
• Make on time property tax and homeowners insurance payments
• Maintain the home to the lender's satisfaction

Failing to meet any of these can result in the lender triggering the loan due. This means immediate repayment of the loan plus interest. Depending on your financial standing, you may be forced to part with the home to repay the debt. 

Diminishes your equity (and flexibility)

Since interest accrues over time and you can't pay it down, your loan balance grows quickly—leaving little or no equity for yourself or your heirs. This can make it near-impossible to borrow against your equity again in the future or enjoy a nice payday when it comes time to sell. 

Not all reverse mortgages offer federal protection

There are three types of reverse mortgages on the market—home equity conversion mortgages (HECMs), ‍single-purpose reverse mortgages, and proprietary reverse mortgages. Each comes with notable distinctions that can make all the difference in eligibility, terms, and costs. 

While HECMs are insured by the Federal Housing Administration (FHA), the other types don't offer the same level of protection. As a result, you'll have fewer consumer safeguards and stricter terms. For example, HECMs are non-recourse, meaning you'll never owe more than the home is worth—this is not guaranteed with other reverse mortgages. 

You could see an impact on benefits 

Funds not used and sitting in your reserves could be counted as an asset—and subsequently used against you—affecting your eligibility for need-based government benefits like Medicaid or Supplemental Security Income (SSI). When determining if a reverse mortgage is right for you, consider the income or asset threshold for these types of programs—especially if you are or plan to be reliant on them in retirement. 

 Your heirs might run into issues

Reverse mortgages leave heirs with limited options. Say the borrower was to pass away or move into an assisted living facility, the loan would become immediately due. In such events, heirs would be on the hook to repay the loan balance if they want to keep the home—if they can't afford to, they'll likely have to sell the house to settle the debt.

Alternatives to reverse mortgages

If you want to tap into your home equity—without all the red tape—consider the following alternatives. 

Home equity investments

Why they’re competitive: No monthly payments and long repayment terms

If you want to enjoy your golden years with no monthly payments, then a home equity investment (HEI) may be the right tool for the job. You get a single cash payout, in exchange for a share of the home’s future appreciation. You can then repay the investment when the home is sold—or using any other source of funds—anytime during a flexible 30-year term. 

How an HEI and reverse mortgage differ:

• You don’t need to be 62 or older
• No income requirements
• There are no conditional requirements
• HEIs are assumable by heirs 

Home equity lines of credit (HELOCs) 

Why they’re competitive: Cheaper, and you only pay interest on what you owe

A HELOC is a revolving credit line that allows you to borrow as needed up to a certain limit. During the draw period, you only pay interest on what you owe. Once the repayment period begins, you'll repay the balance plus interest through monthly payments. 

HELOCs typically have lower interest rates than reverse mortgages. So, if you need a cash cushion but don't plan on completely relying on the funds, a HELOC in retirement can save you more in the long run.  

How a HELOC is different from a reverse mortgage:

• No age requirement
• No strict loan conditions to maintain
• You will have monthly payments
• You only pay interest on what you use 

Cash-out refinance

Why they’re competitive: Potential to lower monthly mortgage payments and save

A cash-out refinance replaces your existing mortgage with a new loan, allowing you to keep the difference in cash. Additionally, you’ll get a new rate and terms. If mortgage payments significantly eat into your budget, refinancing at a lower rate can help you reduce the cost and put more money back into your pocket. 

How a cash-out refinance and reverse mortgage differ:

• No age restrictions
• You won’t have conditions to satisfy 
• You’ll still pay your mortgage
• Changes mortgage rate and terms

Home equity loans

Why they’re competitive: More affordable than reverse mortgages

Unlike a reverse mortgage, a home equity loan requires regular monthly payments. However, if you need a specific amount of money upfront and can afford the repayment schedule, a home equity loan will be cheaper. This financial tool is a better option if the downsides of a reverse mortgage are too great.

How a home equity loan is different from a reverse mortgage:

• You don’t have to be 62 or older
• There are no loan conditions 
• There are monthly payments associated with the loan

Frequently asked questions

What is the biggest problem with a reverse mortgage?

The biggest issue with a reverse mortgage is the high cost and the lender's ability to trigger the loan due if a borrower fails to meet conditions—like falling behind on home upkeep. In most cases, homeowners are not prepared to pay the cost of their loan, which becomes immediately due, resulting in a forced home sale. 

Do people lose their homes with a reverse mortgage?

Since the home is used as collateral, it's possible. A lender can call the loan due when a borrower fails to meet conditional requirements, like paying property taxes or maintaining the home. If the borrower can't pay the loan using funds they have, they may be forced to sell or face foreclosure. 

Who benefits the most from a reverse mortgage?

Reverse mortgages work best for homeowners who have significant equity but limited income, plan to stay in their home indefinitely, and don't intend to leave the property to any heirs. These key characteristics can greatly mitigate some of the downsides of reverse mortgages. 

Final thoughts

If you want to bolster your cash flow in retirement, a reverse mortgage can be helpful. However, given the apparent downside of reverse mortgages, it’s important to weigh the pros and cons and carefully consider your situation beforehand. Consider speaking with a financial advisor or housing counselor to ensure you understand all the implications. If a reverse mortgage is not ideal for your situation, explore alternatives that can provide you with the cash you need—with fewer disadvantages.

Ready to tap into your home equity for better golden years? Explore Point’s Home Equity Investment today—prequalify with no commitment to continue your application. 

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