Reverse Mortgages: Do the Benefits Outweigh the Risks?

The reverse mortgage was invented decades ago to help seniors facing economic hardship access the equity in their homes. Between 1990 and 2010, more than 660,000 reverse mortgages were issued, according to the AARP. Today, the products are aggressively marketed through ads featuring Boomer-friendly spokespeople such as Henry Winkler (the Fonz from Happy Days). But these products are complicated, expensive and ripe for abuse, which lead a reader named Fred to ask:

“What is your opinion about reverse mortgages? So many financial planners are pushing this sort of thing, but I heard that fees are steep.”

Home Equity Conversion Mortgage (HECMs) are the most popular reverse mortgage available. They are federally insured and offer certain borrower protections. Seniors who either own their homes outright or have low mortgage balances can take out reverse mortgages and convert their equity into cash — either as a lump sum, monthly payment or line of credit, or some combination of the three.

There are no income or credit requirements, and the loan has no monthly payment. Instead, the lender pays the homeowner, and the reverse mortgage balance rises as a result, accruing interest and fees. Lenders get repaid when the owner either moves or dies, and the home is sold. HECMs are insured by the Federal Housing Administration, so if for the sale price of the home falls short of the loan amount, FHA pays the lender the difference.

“Reverse mortgages are full of pitfalls and they are very expensive — but they are very valuable to the people for whom they work,” says Margot Saunders, at counsel with the NCLC. “If you are sitting on a mortgage and you can afford to make payments on it, and have home equity and other assets, this is probably not a good idea. But if you are 85 years old and have $250 a month in income and a $500,000 house, it’s a great idea no matter how much it costs, because the lender will give you money you don’t otherwise have.”

In short, these pricey loans can be a lifeline for low-income seniors. What they aren’t is a cost-effective source of cash to buy sports cars or dream vacations, although the industry has aggressively marketed them that way. Lenders have also falsely pitched reverse mortgages as some kind of government benefit program, or part of the economic stimulus plan — and been sued by states for doing so.

The amount someone can borrow depends on their age and the amount of equity in the home, but the maximum is $625,500. (The loan limit was raised in 2009 as part of the federal stimulus law and is set to expire Dec. 31, after which it reverts to $417,000.)

The Risky and Expensive Sides of the Lifeline

Reverse mortgages also come with hefty fees, which can run as high as 5% of your home’s value by some estimates. The FHA charges everyone who gets one a mortgage insurance premium fee of either 0.01% or 2% up front, as well as ongoing annual fees. The HECM Saver loan, created in October 2010, has lower fees, but typically higher interest rates and more restrictions on borrowing. Consumers also have to pay a fee up front for third-party counseling to make sure they have a clear understanding of their options.

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Reverse Mortgage: Is it a Good Idea?

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