The Hidden Dangers of Reverse Mortgages

Reverse mortgages are a financial product that can allow homeowners to access the equity they have built up over the years. While it can be a useful way to boost income during retirement, there are some serious drawbacks to this arrangement that can end up costing you dearly. It is therefore important to be fully aware of the hidden dangers of reverse mortgages to understand if this path is right for you.

There are no doubt instances when a reverse mortgage benefits homeowners, giving them an infusion of cash later in life when their income might be lagging. However, because your house is securing the loan, you need to be absolutely clear about the contours of this arrangement before signing on the dotted line.

What Is a Reverse Mortgage?

In order to understand why a reverse mortgage might not be the best fit for you, it is helpful to understand how reverse mortgages work.

A reverse mortgage is a loan provided by a financial institution that is secured by the equity you have accumulated in your house. Unlike with a standard mortgage, whereby you will make regular installments to pay off your loan balance, with a reverse mortgage you will be receiving monies.

In practice, this will make the loan balance increase over time, as both interest and principal will grow with every payment. Just like any loan, a reverse mortgage will need to be repaid eventually.

If the mortgage holder or their beneficiaries do not have sufficient funds to repay the balance due, the home will be sold with the proceeds used to pay off the debt.

Note that reverse mortgages are very specific types of financial arrangements which not everyone can qualify for. For instance, at least one of the individuals signing the reverse mortgage must be 62 years old.

Another stipulation is that the home being used for the reverse mortgage must also be the primary residence of the mortgage holder. Once this is no longer the case (either because of a death, a move, or selling of the house), the reverse mortgage must be repaid.

What Are the Downsides of a Reverse Mortgage?

There are pros and cons to any financial decision. In this article, we are purposefully spotlighting the negative consequences of a reverse mortgage. Here are some of the reasons that you might want to be cautious about this type of arrangement:

(1) Decreasing your equity: For many, homeownership is a central goal of their personal finances. Buying a house and then paying off a mortgage is a way to build wealth that can be passed down to future generations. By taking a reverse mortgage, in effect you are reversing this process, gradually saying good-bye to the equity that you have labored to accumulate over the years.

(2) The financing is not free: Taking out a reverse mortgage, like any loan, does not come for free. You (or your beneficiaries) will be on the hook for interest payments, which will increase over time as the balance of the loan goes up as well.

In addition, there are a number of other fees that you will need to contend with. This includes an origination fee, closing costs such as a home appraisal, and mortgage insurance.

(3) Ongoing obligations: Just because you take a reverse mortgage does not mean that your obligations as a homeowner have ceased. You will still be responsible for property taxes, maintenance costs, and any applicable homeowner fees.

These payments are part of the reverse mortgage contract, making them an official part of this financial arrangement. If you begin missing these payments, your reverse mortgage loan could be called. If you do not have the money readily available, you could be forced to sell the house you are living in to pay the debt you owe.

Mortgaging Your House

It is important to internalize that taking a reverse mortgage could place your house in peril. Still, for some, this could be worthwhile, but only if you are comfortable with the financing arrangement and are confident that you will have the wherewithal to stay current on your obligations.

In addition, if leaving behind an inheritance for your beneficiaries is a priority, a reverse mortgage is probably not right for you. If you have not paid the loan back before you die, your relatives will need to figure out a way to come up with financing or sell your house in order to repay the reverse mortgage.

You have likely spent a lifetime building up your ownership of this property. Before you pursue a reverse mortgage, make sure to ask yourself if you are ready to risk your home for some extra cash. If the answer makes you squeamish, you should consider other options.

Conclusion: Considering Other Options

A reverse mortgage is one option to consider if you are unable to maintain both your lifestyle and your home with your current income. But, there are others.

For instance, you could think about downsizing, selling your house and moving to a smaller place or a cheaper location. Maybe you have items that you are no longer using that you could sell to pad your pockets as well. You could also find other ways to increase your income, perhaps by finding part-time work or embarking on a side hustle.

One item is clear, it is important that you fully understand and appreciate all the implications of reverse mortgages. This will prevent you from being surprised by any hidden dangers of a reverse mortgage, while making sure that you are fully informed of all the aspects of this financial arrangement.

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