The Reverse Mortgage Dilemma

With the economy still in slow recovery mode and real estate continuing to lag, many clients and friends have asked about the wisdom of taking a reverse mortgage for themselves or their aging parents.  Not a simple question!  But to properly address the issue, we need to first understand what a reverse mortgage is and how it operates.

Perhaps the simplest explanation is that a reverse mortgage (as the name implies) operates in the opposite direction of a traditional mortgage loan.   The borrower receives either a lump sum, monthly payments or access to a line of credit - all of which are based on the value of the property, the applicants age,  and his or her life expectancy.   There are generally no credit or income requirements and - most importantly- no monthly payments are required.  

Sounds lovely, right??? Not so simple.   Here are a few serious 'cons' that may outweigh the "pros' :

• Reverse mortgages for seniors have high closing costs. The senior must pay origination fees that are about double what they are for conventional mortgages and mortgage insurance. The interest rate is variable and is generally several points higher than conventional loans.

• For seniors who depend on Medicaid or other state or federal programs, it’s important to consider if reverse mortgage payments will affect their eligibility. 

• In the Federally sponsored programs, property values are often based on HUD statistical data- not actual appraised value.  This can sharply diminish the amount of available equity- particularly in the current market.  

• Borrowers are responsible for paying taxes, homeowners insurance, maintenance costs and other expenses. If they don't, the loan may become due.

• More importantly, the balance can (and does) continue to grow quite rapidly because you are paying interest on interest each month that the loan remains outstanding.

This last factor is perhaps the most telling aspect.   The reverse mortgage is a classic case of 'negative amortization'- i.e. the principal balance grows instead of decreasing as in a conventional loan.  And this can easily strip all the equity from the property over time.



Like taxes, "Uncle Sam" will come calling to collect from the estate when the borrower passes away.  Unless there is no estate to consider, here are a few alternatives you may examine before deciding on a reverse mortgage:

• A line of equity may be an alternative. There are fewer fees, and the money is available on an as-needed basis, but it requires monthly payments.
• Refinancing the home with a conventional mortgage may save mortgage insurance fees that a reverse mortgage would require. However, this too requires monthly payments.

As in all complex financial matters, seek the help of capable professionals and agencies such as AARP before acting.