A reverse mortgage allows homeowners who are age 62 or older to convert home equity into cash without having to sell their house. And if you've heard of this concept, you may be wondering: Are reverse mortgages a scam? A process that entices elderly folks to cash out the equity in their beloved homes while they are unemployed, on a fixed income, or otherwise unable to financially support themselves seems, well, predatory. But there are many circumstances in which a reverse mortgage can be extremely helpful for a discerning and knowledgeable borrower.
Here are some basic educational tips and warning signs to consider when deciding if a reverse mortgage is right for you—or for someone you love.
What is a reverse mortgage, and who is eligible to get one?
Reverse mortgages are also known as Home Equity Conversion Mortgages (HECMs). Homeowners over age 62 (or a married couple in which at least one partner has reached age eligibility) can use this loan product to cash out some of their home equity to cover living expenses and to improve cash flow.
The Federal Trade Commission explains: "There are three kinds of reverse mortgages: single purpose reverse mortgages, offered by some state and local government agencies, as well as non-profits; proprietary reverse mortgages, [aka] private loans; and federally-insured reverse mortgages, also known as Home Equity Conversion Mortgages (HECMs)."
The least common and the least expensive is the single purpose reverse mortgage, but they all come with a price tag. Loan origination fees and variable interest rates tend to make this loan product particularly tricky, but the premise is straightforward: Instead of making a monthly payment to the mortgage company, the mortgage company makes a monthly payment to you.
What to watch out for to make sure a reverse mortgage works for you:
Don't miss a tax payment.
The benefit of a reverse mortgage is that you get to keep the deed to your house, and your lender essentially pays you to live there. The downside is that homeownership bills are still your burden to bear. Keep paying taxes, utilities, homeowner association fees, and all the other obligatory payments. As with any other mortgage, a lapse on these fees and bills could become a reason to call the loan.
Plan who is going to pay back this loan.
That's something to discuss with your possible heirs. If your family wants to inherit the house someday, then you should be very careful with how much you take out in a reverse mortgage. The caution isn't that heirs will be on the hook for the loan balance; in fact, the concern is much greater.
The FTC explains: "Most reverse mortgages have something called a 'non-recourse' clause. This means that you, or your estate, can't owe more than the value of your home when the loan becomes due and the home is sold. With a HECM, generally, if you or your heirs want to pay off the loan and keep the home rather than sell it, you would not have to pay more than the appraised value of the home."
Yes, you read that correctly. If heirs wanted to keep the home in the family, they would have to buy back the house that you already bought. Otherwise, the bank owns the house when the borrower passes on.
Beware of salespeople.
Just like a used car salesperson isn't going to show you all the scratches on every vehicle on the lot, the person selling you this loan isn't going to share all the possible pitfalls of this product. It is important to read up on these cautionary tales beforehand. Prepare for how you—and your family—will address them, should they arise.
For many people, a reverse mortgage is a good option when it's the only option—but don't let anyone tell you that this is a magic bullet. And, certainly, beware if someone is offering a reverse mortgage in combination with other paid services, such as insurance, home repairs, or anything else that will bind those reverse mortgage payments to another financial obligation. If you smell a scam, report it to the FTC, or the state's Attorney General's Office or Banking Regulatory agency.
The top three scenarios when a reverse mortgage can be really useful:
Nobody else wants this house anyway.
While most Americans hold their wealth in their homes, not every house is a dream house. An inherited house can be both a gift and a curse, especially when the heirs aren't financially prepared to maintain the home, pay the taxes, or keep it occupied. If an aging person already knows that their kids plan to sell the house anyway, then a reverse mortgage isn't a half bad idea. With proper financial planning, it can allow the person who loves the house most to enjoy the maximum benefit.
You have immediate medical expenses or care costs.
If life-saving medical treatment or particular eldercare services are otherwise beyond financial reach, leveraging the wealth in a home could be the very best option available. A 2019 Northwestern Mutual study found that "while 10,000 Baby Boomers turn 65 every day, nearly one in five (17 percent) have less than $5,000 saved for retirement and 20 percent have less than $5,000 in personal savings...On average, people think there is a 45 percent chance they will outlive their savings, and 41 percent have taken no steps to address it."
Many people retire without a pension, and those who were in low-paying jobs to begin with likely dumped all their pennies into their homes. It only makes sense to consider their home an investment that must show returns during their time of need.
Aging in place is your priority.
For most seniors, aging in their home is a sign of independence and emotional support from loved ones. Being housed in a nursing home or aging-support facility can be demoralizing, as well as extremely expensive. It is important to discuss all financial options with everyone in the family and to confirm with medical professionals whether aging in place is realistic. If everything checks out, the benefit of the reverse mortgage is that it finances one's ability to simply stay put.
This is particularly beneficial if the home already has the costly accessibility upgrades that would promote comfort and mobility for many years to come. Dollar for dollar, most older Americans would pay anything to keep their routines and their autonomy. That peace of mind can improve quality of life and make these years some of their most enjoyable. If the house can finance that reality, a reverse mortgage could be a very useful tool to consider.