What is a Reverse Mortgage? And Should You Ever Consider It?

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what is a reverse mortgageAn advertising agent emailed me the other day. They had a high-paying offer for me if I were to post their ad about reverse mortgages. I flat out refused. Reverse mortgages are fairly new and at first glance, they don’t seem like too bad of a deal. You have equity in your home that you would like to use while you are alive and the bank is willing to make monthly payments to you to do it. Sounds like a win-win! Well, most likely not. Most of the time, the bank is winning and you are most certainly losing. Let’s start by answering your question, “What is a reverse mortgage?”

What is a Reverse Mortgage?

Okay, so what specifically is a reverse mortgage? According to Investopedia.com, a reverse mortgage is:

“A type of mortgage in which a homeowner can borrow money against the value of his or her home. No repayment of the mortgage (principal or interest) is required until the borrower dies or the home is sold. After accounting for the initial mortgage amount, the rate at which interest accrues, the length of the loan and rate of home price appreciation, the transaction is structured so that the loan amount will not exceed the value of the home over the life of the loan.”

In other words, a reverse mortgage is used when a retiree does not have enough money to survive day to day, but has equity in their house. So, they take out a loan with the bank and promise to repay the loan when they die with the sale of their house (this is set up in their will of course…it’s kind of hard to do all of this from 6 feet underground). Plain and simple, homeowners sign up for reverse mortgages so they can get a monthly paycheck.

So What Are the Drawbacks?

Many of us seem to forget that a bank is a business. No matter what they say, they are not interested in your wants and needs, they are interested in making money, because that’s what needs to be done to survive as a business. So don’t think for a second that you are getting the upper hand when you borrow money from a banking institution.

So what are the drawbacks of reverse mortgages? After all, it sounds pretty cut and dry. You get a monthly check from the bank, and then you’ll owe that amount back once you die. Actually, that’s not quite right.

1) You have to start paying interest again

When you first bought your house, you realized that you would have to pay interest to the bank for the loan. In the end, you paid almost double the amount for your home than what it was worth. If you sign up for a reverse mortgage, you’ll be doing this all over again. The bank will pay you in monthly installments and because of the interest, those payments will only total about half the value of your home. You might not think this is such a big deal since you’ll be dead at the time of repayment, but this action will result in less money for you and for your children.

2) The fees are enormous

In order to get a reverse mortgage, you’ll certainly need to pay some fees… a LOT of fees. In my area, I would have to pay a “Loan origination fee” of $2,500 and “Miscellaneous fees” that total another $2,511. In total, the average amount of fees can easily rack up to more than $5,000. No matter what the bank calls these fees, they are basically made to cover their butt in case the housing market tanks again. Their risk is diverted to you, which means that you’re getting a raw deal.

20141029 - reverse mortgage photo3) You have to pay the balance if you move out

If you move out of your home, you’ll need to pay all of those monthly checks back to the bank (and don’t forget about the interest!). This doesn’t sound like a big deal if you plan to live in your house until you die, but what if you’re forced into a long-term care facility? If you don’t step foot in your home for a year, then the bank considers you moved out (even if you still own it) and will require a payment from you.

Talk about added stress to an already bad situation! For many, the reason they take out this loan against their house is because they didn’t have any money in the first place, and now they’re expected to pay back the loan in full while they are still alive? This probably isn’t going to happen.

4) Your house will not be enjoyed by your heirs

If you sign up for a reverse mortgage, your home will likely not get passed down to your children. In fact, it will only create a larger hassle for them. Not only will they not be able to have the house (because of the big price tag owned back to the bank), but they will now have the hassle of quickly selling the house in order to give those greedy bankers their money before they sick their collectors on you.

Do Everything You Can to Avoid Reverse Mortgages

So what is a reverse mortgage? It’s a rip-off. Avoid them at all costs. If you simply can’t survive on your current income, but own your house outright, then you need to sell your house. It probably isn’t your most favorite option, but it is likely your only sane one. Sell the house, get your full value out of it, buy a much cheaper house (or rent for cheap), and put the remainder of the money in a high-yield savings account. Chances are that you can live off this money for much longer than you could from the bank’s reverse mortgage loan.

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Housing Money

Derek

AUTHOR Derek

My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.

13 Comments

  1. Thank you for this information. I see these commercials for reverse mortgages with a well known actor and it is done so well that you are suppose to feel safe because this well known actor wouldn’t be lying to you. But my instincts tell me that they are only telling you enough truth that will sucker you in. There is a lot of darkness lurking in the details. I thank you for making the details so much clearer.

    • You’re welcome Janie! Yes, I have seen those commercials and they can be quite convincing with that well known actor selling the product. However, you must remember that he needs to make a living and commercials are likely his only way to do that at this point. The bottom line is that reverse mortgages are good for the bank, not for the customer. If money is scarce for the elderly, it is best that they sell their home and live off that lump sum of money. It’s not the easy choice, but it is often the best one.

    • Glad you think so Connie. I would never consider a reverse mortgage. It just never makes sense financially.

  2. Derek,
    Nicely done – again. Great blog and you are absolutely right. Stay as far away from reverse mortgages as you possibly can.

    Side note – against yours (and many others’ better judgment, myself included), my wife did pull $50K out of her 401 and we paid off our mortgage. Of course, we’ve now got a $50 loan out that we have to pay back and of course, the minute we did it the market soared – ha! (you guys can all thank my wife for the jump in your retirement funds – ha!) Nonetheless, I have to admit I am kind of glad that we did this ’cause now our home is completely secured. It’s going to be an interesting ride to see how things work out over the next 12 months or so.

    How goes it on your mortgage pay off?

    • Hi Jim! Thanks for the compliments on the article, and I’m glad you agree. Yes, thank you so much for the soaring market! 🙂 Haha, seriously though, I am glad you and your wife are happy with your mortgage payoff – congrats! Please keep me updated on the details over the next 12 months.

      My mortgage payoff is going well. I budgeted well in October and will report about that on Friday! As for the truck sale, I just put it on the market yesterday and have already had one interested party. But, of course, he could not come up with the money. 😉 Stay in touch Jim!

    • I think it’s risky for almost everybody Amos. It is best to just steer clear of reverse mortgages.

  3. Derek, what happens if a husband and wife take out a reverse mortgage and one of them dies, does the survivor need to start paying the mortgage back?

    • As I understand it, if both spouses are on the reverse mortgage and one of them dies, then the reverse mortgage payments can continue. If, however, only one spouse was listed on the reverse mortgage and they die, then the reverse mortgage loan often becomes due and needs to be repaid according to the terms. This of course, is all up to the banks discretion and the terms in their contracts. Great question!

  4. I think revers mortgages are a real rip off! My mother-in-law got one a few years ago, against all her family’s advice. For some reason, she felt she needed the money. God knows why, she is living off the interest of $400,000, and her mortgage was only 600 a month. Now she’s stuck and doesn’t want to talk about it, and like you said, her heirs can buy the home, unless they are living there at the time of her death. So she basically gave away a $300,000 home (at the beach)for a $76,000 loan! (sobbing) It is only worth it if you see no way out and have not family at all.

    • Ugh. Yeah, that’s awful! Basically, a reverse mortgage is like going into debt all over again. You’re essentially selling your house, handing that money over for someone to hold permanently, and then borrowing on it. It’s pretty much a terrible deal every way you look at it.


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