Reverse Mortgage Pros and Cons
- Allows you to use the equity in your property to take out a loan that does not need to be paid back until you no longer live in the property
- You continue to own your home outright. Property title is never transferred with a reverse mortgage (unless the property is foreclosed upon due to the non-payment of property taxes or homeowners insurance)
- Not having a monthly mortgage payment provides significant financial flexibility
- The proceeds from a reverse mortgage are tax-free
- There are no limits on how you use the proceeds from a reverse mortgage
- Depending on what type of reverse mortgage program you select, your available borrowing amount may increase over time if interest rates decrease
- Due to government rules, the borrower or the borrower's heirs can never owe more than the value of the property, even if the value of the property decreases over time and the reverse mortgage balance is greater than the value of the property when the mortgage is due in full
- In the case where the reverse mortgage balance exceeds the value of the property, 95% of the property value, when sold, goes to pay off the reverse mortgage
- For example, at the end of a reverse mortgage when the loan balance is due in full, if the mortgage balance is $115,000 but the property value is $100,000, $95,000 in proceeds from the sale of the property ($100,000 * 95% = $95,000) will go to paying off the mortgage balance and the reverse mortgage is considered paid in full (the remaining $5,000 in proceeds is used to pay transaction fees)
- So even though the outstanding balance on the reverse mortgage is $115,000, the debt obligation is satisfied in full by paying 95% of the property value, as determined by a third-party appraiser
- This eliminates the risk that the borrower will pass the reverse mortgage debt onto your heir
- Your mortgage balance increases over time. This is called a negatively
- With a reverse mortgage, instead of paying interest as part of your monthly mortgage payment, you do not make a monthly payment and the interest is added to the mortgage balance
- This means you pay interest on the interest as the mortgage balance increases over time, which is a real financial negative for the borrower
- You lose equity in your property. With a reverse mortgage, the amount of equity you have in your property declines over time in comparison to if you do not have a reverse mortgage
- You potentially leave less money to your heirs because the reverse mortgage must be paid off if you pass away or move out of the house. Paying off the reverse mortgage means that your heirs receive less money when the property is sold
- If your property does not increase in value, you may lose all the equity in your property. The principal balance of the reverse mortgage increases over time until it is paid off when the borrower sells the property, refinances the reverse mortgage or passes away. If the value of your property does not increase then the value of the reverse mortgage could match or exceed the value of your property
- Although you can never owe more than the value of your property, you may lose nearly all of the equity in the property meaning there would be little to no money for you or your heirs after the reverse mortgage is repaid
- You are required to pay an up-front and ongoing FHA Mortgage Insurance Premium (MIP). The up-front MIP fee is paid for with the proceeds of the reverse mortgage and the ongoing MIP fee is added to the mortgage balance. Although the borrower does not pay for the FHA MIP fees out of pocket, they are meaningful expenses that the borrower should consider when evaluating a reverse mortgage
- The borrower is required to perform maintenance and upkeep to make sure that the value of the property is maintained. This is an additional expense that the borrower should consider
- Example: Worst Case Scenario for a Reverse Mortgage - Total Loss of Equity
$700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0$100,000$286,200$186,200$518,412$659,797($141,358)
- Reverse Mortgage Balance
- Property Value @ 2.0% Appreciation
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- FREEEandCLEAR Related Resources
Getting a reverse mortgage is a major financial decision that involves both benefits and risks. Reverse mortgages are relatively complicated so there is a lot of information for borrowers to consider. While a reverse mortgage eliminates your monthly mortgage payment, your loan balance actually increases over time which can significantly reduce the equity you have in your home. Reverse mortgages can provide greater financial freedom but that comes at a long term cost and the worst case scenario can be very challenging for borrowers. Given the financial commitment and potential risk involved, prospective borrowers should always weigh the pros and cons of a reverse mortgage before applying.
The chart below outlines the positive and negatives of a reverse mortgage including key borrower benefits and challenges. There are several factors for borrowers to understand, both good and bad. The pros of a reverse mortgage include eliminating your monthly mortgage payment, accessing a significant amount of equity in your home tax-free and retaining ownership of your property.
Additionally, you are not required to pay back the mortgage unless you sell or vacate the property and there are no restrictions on how you spend the proceeds from a reverse mortgage. Finally, according to industry regulations, you can never owe more than your property value, even if you end up with negative equity.
While a reverse mortgage offers several advantages, there are drawbacks that borrowers should be aware of. Cons of a reverse mortgage include that your loan balance increases over time -- this is called negative amortization -- which decreases your property equity, especially if home values do not appreciate. This also reduces what you leave for your heirs, which may or may not be a priority.
Also, your interest expense is added to your mortgage which increases your loan balance plus the interest rate for a reverse mortgage is higher than a standard forward mortgage. It is also important to highlight that you are still required to pay property tax, homeowners insurance as well as property maintenance costs. Finally, you are required to pay an upfront and ongoing mortgage insurance which are extra costs for borrowers even though they are added to your loan.
Review the reverse mortgage pros and cons in the chart below to help you decide if it is the right option for you.
Use the FREEandCLEAR Lender Directory to find leading lenders in your state that offer reverse mortgages.
The example below the chart demonstrates one of the biggest risks of a reverse mortgage -- that you could lose all the equity in your property as the reverse mortgage balance grows over time. The example shows that if the interest rate of a reverse mortgage is greater than the property appreciation rate then you could lose all of the equity in your property, depending on the length of your reverse mortgage. Although the example represents the worst case scenario for a reverse mortgage, it illustrates the downside risk that prospective reverse mortgage borrowers should consider. Review the chart and example below so that you can understand the upside and downside of a reverse mortgage to decide if it is the right option for you.
The red line in the chart shows how the principal balance for a reverse mortgage with an initial balance of $100,000 and an interest rate of 5.1% grows over time. At the end of year 30, the principal balance for the reverse mortgage is approximately $660,000.
The blue line in the chart shows how the value of the property changes over time using a $286,000 initial property value and 2.0% annual rate of property appreciation. At the end of year 30, assuming the property value increases 2.0% every year, the value of the property is approximately $520,000.
The green line shows the equity in the property, or the value of the property minus the balance of the mortgage on the property.
In this example, because the reverse mortgage balance increases faster than the property value, at the end of year 30, the owner’s equity in the property is approximately negative $140,000. Although you can never owe more on your reverse mortgage than value of your property, you can lose all of your equity which means that your ownership stake in the property is worth nothing. The chart is only one example and represents the worst case scenario for a reverse mortgage. It is certainly possible for the property value to increase faster than the reverse mortgage balance, in which case your equity in the property will grow. Additionally, most reverse mortgages are shorter than 30 years which limits the potential growth of negative equity. But this example effectively demonstrates the biggest downside of a reverse mortgage -- you could lose all of your equity in your property.
This example shows a reverse mortgage after 30 years but there is no set term for a reverse mortgage. A reverse mortgage lasts as long as the owner lives in the property or until the mortgage is paid off so the actual term could be shorter than, or potentially longer than, 30 years.
Reverse Mortgage Risks: https://www.consumerfinance.gov/data-research/research-reports/issue-brief-costs-and-risks-using-reverse-mortgage-delay-collecting-social-security/