Many people' knowledge of reverse mortgages is a bit fuzzy, and where there is fuzz, there's often fear. In this case, there should be some fear, or at least some caution. Reverse mortgage pitfalls can turn golden dreams into sad nightmares.
Pitfall #1: No Crystal Ball
Reverse mortgage loans don't have to be repaid as long as you own and live in your home. For many people, maximizing their reverse mortgage proceeds means staying in the house and drawing monthly checks as long as possible. However, health concerns or changes in lifestyle can derail the best-laid plans. You may need long-term care or decide to move, and then your loan comes due and the checks stop. For government-backed reverse loans, reverse mortgage servicers are required by HUD to verify, on an annual basis, that you are still living in your home. Most reverse mortgage documents state that the loan must be repaid if the home becomes unoccupied by the borrower.
Pitfall # 2: Better Options
Reverse mortgages can be expensive, and may not always be the best solution for financial problems. If you're retired and overwhelmed by debt, for example, it may be smarter to enroll in a debt management plan or file bankruptcy than to use up all your home equity. Check with a lawyer -- some or all of your home equity and retirement may be protected. Reverse mortgage counselors advise people to consider alternatives, such as taking in a roommate or getting a part-time job to supplement income, selling unneeded assets for extra cash, or choosing a home equity loan (which is cheaper) if the homeowner can qualify.
Pitfall #3: High Pressure Tactics
It's best to stay away from unsolicited reverse mortgage offers. Vulnerable seniors have been targeted by high-pressure salespeople, lured with promises of easy money for trips, shopping sprees and other fantasies, and then bamboozled by confusing loan terms and fast talk. For most people, the best reverse mortgage is the government-backed Home Equity Conversion Mortgage, or HECM. This program is backstopped by rules to protect elderly homeowners -- limiting fees, requiring pre-loan counseling by HUD-approved educators, and performing a financial assessment to make sure the homeowner is capable of taking care of the property and its related expenses.
Pitfall #4: Loss of Government Benefits
While taking a reverse mortgage doesn't affect entitlements like Social Security or Medicare, be careful about the way you structure your payout if you receive Medicaid or Supplemental Security Income (SSI). Reverse mortgage payments can affect your eligibility in some cases. The reason for this is that any proceeds you receive from your loan that you don't spend right away (for example, if you opt for a lump sum instead of monthly payments or a line of credit) will count as an asset when qualifying for aid. If your assets exceed program thresholds (usually $2,000), you could be declared ineligible. If you receive or anticipate receiving these benefits, consult a financial adviser to make sure the reverse loan payout is structured correctly to allow you to maintain your eligibility.
Pitfall #5: Overpaying
While fees for the HECM program are restricted, interest rates are not set by the government. Homeowners who don't compare loan offers from competing reverse mortgage lenders risk paying more than they should.
Comparing reverse mortgage quotes can be complicated. Instead of using a standard APR disclosure, reverse mortgages come with TALC disclosures -- that stands for Total Annual Loan Cost. Your reverse mortgage counselor can help you read and understand the disclosures, compare reverse mortgage quotes and choose your best deal.
Even though only HECM applicants are required by law to get reverse mortgage counseling, reverse mortgage pitfalls can happen to anyone. In fact, they are more likely for those who go for a less-regulated private reverse mortgage. To avoid the downsides of reverse mortgages, attend reverse mortgage counseling, even if not required, get someone you trust to help you navigate the process, or consult with a financial adviser before committing to any reverse loan program.
Reverse mortgages are great products when taken out by the right people for the right reasons. Once you navigate the pitfalls, a reverse mortgage may be a great loan for you.