Reverse equity mortgages; advantages and disadvantages

Credit nowadays is not as easily available as it was years ago and many people; especially seniors, are looking for other directions for sources of income than just what they get in their pensions, have in their pockets and in their credit cards. In this economy, seniors may not even qualify for a loan that requires a monthly payment because their income is fixed or too low.

Generally, a reverse equity mortgage is available to any homeowner who is 62 years of age or older who is living in their home, will remain in the home, and has equity in the property. The more equity, the higher the value of the house, and the older the homeowner, the more a lender will allow a homeowner to borrow. The reason is obvious. If the owner is ninety years of age, his or her life expectancy is low and the mortgage will become due in a very short time thereafter.

Seniors who have built up equity in their homes, a reverse equity mortgage is an attractive alternative to a refinancing or home equity loan. A reverse equity loan is enticing because it requires no payment while the owner is alive. They can still use their homes as their primary residences, providing they don’t sell or transfer their home in someone else’s name. The senior can do whatever they wish with the loan proceeds such as use the funds to pay off debts, go on extended vacations or as a line of credit when they need extra cash.

The federal government insures Home Equity Conversion Mortgages. Some private lenders offer them as well. In general, HECM loans will have lower costs or interest rates associated with the loan, and the lender under this program is required to provide counseling to the homeowner before the loan documents are signed.

Nevertheless, many seniors prefer to go the ‘reverse mortgage route’ because the loan doesn’t become due until the homeowner dies. That may be a great idea if the homeowner is single and has no family to leave his estate to. One less bill to pay can really make Reverse mortgage loans seem like a good idea. However, anyone who is seriously considering this option needs to fully understand that these can be really an expensive venture with extra costs attached. Investigating and understanding the advantages and disadvantages of this loan product is important.

Typically a lender will appraise the house and do a home inspection to determine the value and condition of the home. A loan amount of up to 80 percent of the value of the home is made available to the homeowner after deducting costs associated with the loan. These costs can include closing costs and insurance that the homeowner is expected to pay.

Interest is charged on the amount the homeowner borrows. Some loans require monthly servicing costs. But the lender will want to ensure that any existing mortgages on the house are paid off and usually will make sure that any other liens on the house are paid as well. So while the homeowner has no monthly payments to make, each time they access the loan and interests and costs are added on, the balance of the mortgage goes up, not down. At some point, the loan may become higher than the actual value of the house at the time the loan becomes due.

The costs associated with a reverse mortgage are usually also include: a home appraisal fee, application fee or closing fee, a repayment penalty for selling the house or moving out within three years of obtaining a reverse mortgage and fees for independent legal advice.

The homeowner is still responsible for making sure that the property is kept in good condition, that the taxes are paid and that there is insurance paid on the house. If the homeowner fails to keep up these conditions, the loan can be called into default. Another reason default can occur is if the homeowner moves from the property and rents it to another person or alternatively, lets a relative of family member move in and take on the responsibility of looking after the house.

There are two main problems seniors experience with these loans. First, the senior does not understand the actual amount they will have available to them because they do not understand the costs associated with the loan. They only learn what the available proceeds are after they have signed all the paperwork. But by then, it is too late. This is a real problem for seniors who want to pay off all their debts but realize too late that the amount of the reverse equity mortgage will not stretch to cover all the bills owed. The result is that the senior may no longer have to pay a mortgage, but will still have credit card bills or other loans that require monthly payments.

Second, many seniors don’t realize that when they use the loan proceeds, interest and other monthly costs are added on to the loan and the balance owing becomes higher. That is because reverse mortgages are subject to higher interest rates than most other types of mortgages. As anyone who has ever taken out a mortgage on their home knows, the interest on mortgages accumulate over the years.

At the time of the death of the homeowner, his or her estate will have to repay the loan and interest in full within a limited time. The time required to settle an estate can often exceed the time allowed to repay a reverse mortgage.

Imagine if you will, the homeowner has taken out the reverse mortgage so that he and his wife can have money to spend in their senior years. The loan is for $200,000 and twenty years later, he dies and the reverse mortgage is now due. The 10% interest on the loan alone over a twenty-year-period is $256,720 and with the actual loan also becoming due, the balance on the entire loan is $456.720. Where is the surviving wife going to get that kind of money? What originally was their home, free and clear of all debts before the loan was taken out, is now going to be sold and she is going to have to find somewhere else to live.

Further, since the principal and interest will be repaid to the lender at the time of the death of the homeowner, there will be less money in his estate to leave to his children or other heirs.

I am not really convinced that taking out a reverse mortgage on your home is a good idea unless of course, you are single or widowed and you have no one to leave your estate to. If you are in that position, then take out the loan for whatever you can get and spend, spend and enjoy your sunset years to their fullest. After all, when the house is taken over by the lender, it won’t be your problem; it may even be the lender’s problem if the house is worth less that the actual money your lender gave you to spend during those wonderful sunset years.