No Such Thing as a Free Lunch: Disadvantages of Reverse Mortgage

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Maybe you heard this 100 times, and I'm saying the adage again: there is no such thing as a free lunch!

This is true when it comes to reverse mortgage. The reality is, even the wisest reverse mortgage strategy has its costs! For this, retirees should understand reverse mortgage disadvantages first before making the decision to avail the loan.

Here are some of the reverse mortgage pitfalls:

1.) High Costs.

The Federal Housing Administration-backed Home Equity Conversion Mortgage (HECM) program, popularly known as reverse mortgage, includes quite a number of fees and charges including initial and annual mortgage insurance premium, appraisal fee, title search, inspections, and origination, interest and servicing fees among others.

For the origination fee, a retiree may be required to pay up to $2,500 if the property is valued at less than $125,000. If the property has value that exceeds $125,000, the retiree may be charged $2,000 and an additional 1 percent for the property worth more than $200,000. Servicing fee, on the other hand, ranges from $30 to $35.

The retiree, however, has the choice to collapse the aforementioned fees and charges into the loan and pay them back over time with interest.

2.) Compound Interest.

Bear in mind that reverse mortgage is not a need-based entitlement. While the federal government ensures the program, it is never up for anyone to grab and walk away with as if winning a lottery ticket. Lenders engage in reverse mortgage as business entities, thus, are justified to be repaid the amount they lent, plus the interest on it. The not-so good news is, what they charge are not just interest, but compound interest.

Compound interest is interest on interest. That means when a retiree borrows, say, $125,000 at 4 percent annual interest rate, after a year, the retiree owes the lender $130,000 ($125,000 principal+$5,000 interest).

After two years, the retiree owes the lender $135,200 ($130,000 principal and interest in year 1+$5,200 interest for year 2). Notice that interest in year 2 is a bit higher than year 1. This is because, in reverse mortgage, lenders earn interest on interest.

The good news, however, is that lenders are willing to wait to liquidate their earnings. The loan will only be repaid when the homeowner passes away or permanently moves out of the property.

Moreover, a retiree may choose to refinance existing reverse mortgage especially if the real estate landscape is highly favorable. That is, when the property increases in value, refinancing may pave to higher home equity.

3.) Effect on Future Financing and Need-based Assistance.

By availing reverse mortgage, a retiree is also creating a liability. Since reverse mortgage is considered a loan rather than an income, it may have an impact on acquisition of credit cards or applications for car and other kinds of loan.

Government assistance like SSI (Supplemental Security Income) and Medicaid may also be negatively affected.

Reinforcement

With knowledge on reverse mortgage disadvantages, retirees will be able to make informed decisions about their retirement investments. Existence of reverse mortgage disadvantages should reinforce seniors to talk with an HECM counselor, FHA-approved lenders, financial adviser, and among immediate family members before jumping on the reverse mortgage wagon. These people can help retirees navigate the confusing world of reverse mortgage, and assist them live their retirement plans.

 

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