Top Reverse Mortgage Misconceptions and Myths
Reverse mortgages can be confusing because they are so different than a regular, forward mortgage that most people are familiar with. In fact, in most respects, a reverse mortgage is the exact opposite of a regular mortgage. You have no monthly loan payment, your mortgage balance goes up not down over time, the qualification process is more focused on the property than the applicant's income and employment, you personally receive a significant amount of proceeds when the loan closes plus there is an age limit as one of the borrowers must be at least 62 years old. This also means the most borrowers have no need to understand how a reverse mortgage works for most of their lives.
These conditions create a significant number of misunderstandings about reverse mortgages. Many prospective borrowers believe they no longer own their homes, their equity belongs to the lender, their property value and equity always increases, their loan balances never changes, their interest rate cannot increase and they are not required to pay property tax and insurance after their loan closes. All of these points, however, are wrong and represent common reverse mortgage myths.
In light of the complexity and risks involved, it is especially important that borrowers can separate fact from fiction. Below we review the top reverse mortgage misconceptions and what borrowers need to understand about each point. A clear understanding of these important topics better positions you to determine if a reverse mortgage is right for you.
I Lose Ownership of My Home
Just like with a regular mortgage, you do not lose ownership of your home with a reverse mortgage. The title of the property is never transferred with a reverse mortgage and the bank does not own your home while the reverse mortgage is outstanding. The borrower maintains ownership of the property until the property is sold or the borrower passes away.
Review our comprehensive Reverse Mortgage Guide to understand how property ownership works with a reverse mortgage
The only way that you an lose ownership of your home with a reverse mortgage is if you fail to pay property tax and homeowners insurance, which causes you to default on the loan. As long as you pay your property tax and homeowners insurance on time, the reverse mortgage remains current and you cannot lose ownership of the property.
Equity in the Property Belongs to the Lender
Any equity, or the difference between the value of the property and the amount of the reverse mortgage on the property, always belongs to the borrower as long as they own the property. Depending on how the value of the property changes over time, the amount of the homeowner’s equity may decline as the reverse mortgage balance increases, but the homeowner maintains 100% of the equity in the property.
For example, if you take out a $65,000 reverse mortgage on a $100,000 home, the homeowner equity that belongs to you at closing is $35,000. In five years, if the reverse mortgage balance has increased to $80,000 and the property value has increased to $105,000, then you hold $25,000 in homeowners equity. Although your equity may fluctuate and potentially decline, it always belongs to the home owner and not the lender.
My Property Equity Always Increases
This is false -- homeowners can definitely experience a decline in property equity over the course of the loan. The value of the property may increase at a slower rate than the reverse mortgage balance, which means that the borrower is losing equity in the property. The reverse mortgage balance increases over time while the future value of your property can be hard to predict. If the property appreciation rate, or the rate at which the value of the property increases over time, is lower than the reverse mortgage interest rate then your reverse mortgage balance will grow faster than your property value.
Although a borrower can never owe more on a reverse mortgage than the value of the property, borrowers could lose almost all of their equity if the property value increases at a slow rate, remains flat or declines as the loan balance increases. For example, how much you owe on a reverse mortgage continues to increases even if the value of your home declines due to market conditions or because it falls into disrepair. In a worst case scenario, all of your homeowner equity could be wiped out.
Understand the Pros and Cons of a Reverse Mortgage
When evaluating a reverse mortgage, borrowers should use a conservative property appreciation rate (3% or lower) or contact a real estate agent to understand the expected property appreciation rate in your area. You should make sure that you have sufficient funds for maintenance and upkeep to support the property value. It is also important to understand that you could potentially lose all of the equity in your property, which is one of the main risks of a reverse mortgage.
My Mortgage Balance Never Increases
This is also false. The borrower does not make monthly payments with a reverse mortgage so the loan balance increases over time. Instead of making payments comprised of both principal and interest, the interest expense and other reverse mortgage fees are added to the loan balance. The rate by which your loan balance increases depends on your interest rate, with the higher your rate, the faster your loan balance grows.
By adding interest expense and fees to the mortgage balance every month, you increase the principal mortgage balance plus you pay interest on interest which is one of the biggest drawbacks of a reverse mortgage. Your reverse mortgage balance increases over time regardless of if you take additional disbursements.
I Am Not Responsible for Property Taxes and Insurance
A reverse mortgage borrower must continue to pay property tax, homeowners insurance and other potentially applicable monthly housing expenses such as homeowners association (HOA) fees. If the borrower fails to pay these fees, the property could go into foreclosure and the homeowner could lose the property.
Most reverse mortgage lenders require that borrowers demonstrate their ability to pay for monthly housing expenses included property tax and insurance when they apply for the loan but it is the borrower's responsibility to be comfortable with this ongoing financial obligation.
Understand Total Monthly Housing Expense When You Own a Home
My Interest Rate Never Increases
This is true if you get a fixed rate reverse mortgage, but if you get an adjustable rate reverse mortgage, your interest rate can change and potentially increase. Depending on the type of adjustable rate reverse mortgage you select, the rate can change and increase on a monthly or annual basis. If your interest rate increases, your reverse mortgage balance grows at a faster rate, which means your property value must appreciate at a higher rate to maintain your equity in the home. Be sure to consult your lender and review the pros and cons of an adjustable rate or fixed rate reverse mortgage to understand the option that is right for you.
Review Reverse Mortgage Program Options: Fixed Rate or ARM
My Heirs Can Keep the Reverse Mortgage
If you pass away, sell your property or permanently vacate the home, the reverse mortgage must be paid off in full as the loan is not assumable by another party, even if they take ownership of the home. To pay off a reverse mortgage your heirs can decide to sell the property, pay it off with their own funds or refinance the loan, but the reverse mortgage comes due when you pass away.
You Do Not Pay Mortgage Insurance With a Reverse Mortgage
Reverse mortgage borrowers are required to pay an upfront and ongoing FHA mortgage insurance premium. The upfront insurance is 2.0% of your property value, up the FHA reverse mortgage loan limit, and the ongoing monthly insurance fee is 0.5% of the outstanding loan balance, which increases every month. Both the upfront and monthly FHA insurance fees are added to your loan balance so you do not pay for them out of pocket but they are a somewhat hidden cost that borrowers should be aware of.
You Cannot Shop for a Reverse Mortgage
Because a reverse mortgage can be complicated and overwhelming many people think you cannot shop for a reverse mortgage but this is not accurate. If you are interested in a reverse mortgage we recommend that you contact several lenders and compare loan terms, with a special focus on closing costs. While there is less variation in interest rate pricing among reverse mortgage lenders, you may be able to save money by negotiating lower fees. If you choose an adjustable rate reverse mortgage you may also be able to lower your interest rate by shopping lenders.
Learn How to Save Money on a Reverse Mortgage
You can also use the FREEandCLEAR Lender Directory to find reverse mortgage lenders in your area
Sources
"CFPB Report Finds Confusion in Reverse Mortgage Market." My Home by Freddie Mac. Freddie Mac, June 28 2012. Web.