During conversations about home equity, a common question often arises—are reverse mortgages safe? As with any financial product, it’s an important question to ask. Reverse mortgages are a type of loan for homeowners usually aged 62 or older who want to convert some of the equity they’ve built in their home into cash during retirement.
However, reverse mortgages aren’t like traditional mortgages, and they haven’t always worked for all borrowers due to unscrupulous lenders and people generally not understanding how they work. But new rules and regulations were put into place over the past decade to better protect homeowners who take out a home equity conversion mortgage (HECM). They have evolved to become stable financial tools for retirement planning.
“Reverse mortgages can be an incredibly powerful financial planning tool for retirees,” says Dan Murphy, a certified financial planner with Greater Good Financial. “But, like many other things that are stigmatized, it takes an open mind to take advice and willingness to modify your preconceived thoughts on a subject.”
What Protections Are Available for Borrowers?
Reverse mortgages are safer options today due to the new rules and regulations to protect homeowners and retirees. First, HECMs are insured by the Federal Housing Administration (FHA). When you take out a reverse mortgage, you pay an upfront mortgage insurance premium and finance an annual mortgage insurance premium of .50% of the mortgage balance. This FHA mortgage insurance guarantees that borrowers can access the loan proceeds even if the lender goes out of business.
“I think because reverse mortgages have such a bad reputation, the federal safeguards are extremely beneficial,” says Murphy, who recommends home equity conversion mortgages HECMs to his clients. “Household equity is one of the largest sources of net worth for many retirees. For many, their household equity is one of the main sources of additional funds. I like that you have flexibility [with a HECM]. Normally you can make payments if you’d like, stop your payments if you’d like, access a line of credit or a combination of the three.”
What Is a Non-Recourse Loan?
Another protection is that a reverse mortgage is non-recourse. If your loan balance exceeds the value of your home due to market depreciation, you’ll never owe more than what your home is worth at the time of the sale. This protects you and your heirs, who won’t be obligated to pay the lender the difference between the sale price and the loan balance.
Before you can obtain a reverse mortgage, you must go through reverse mortgage counseling with a third-party agency approved by the U.S. Department of Housing and Urban Development. Counselors make sure you understand how the loan works. They’ll assess your finances to verify that you can meet the ongoing loan obligations, including paying for taxes and insurance. They’ll also provide you with insights on other available options. This protection eliminates the risk that a borrower will enter into an agreement they don’t understand.
What Are a Borrower’s Obligations?
After you’ve completed the required counseling and your HECM is approved, you need to continue to meet your loan obligations to stay in good standing. For example, you need to:
- Continue to own the home, and it must be your principal residence.
- Stay current on property taxes, homeowner’s insurance, homeowner’s association fees (if applicable).
- Maintain your home according to FHA requirements, keeping up with repairs.
What Happens If a Reverse Mortgage Borrower Defaults?
With a traditional mortgage, defaulting on a loan usually means missing payments. With a reverse mortgage, defaulting happens if you don’t meet your obligations. For example, if you quit paying your homeowner’s insurance, let your home go into disrepair, or if you move, and the issue can’t be rectified, the lender may call the loan due and payable.
When the loan is due and payable, you can sell the property to repay the debt, or the lender could accept a deed in lieu of foreclosure. But if you don’t take steps to pay the loan, the lender could foreclose.
With all the protections in place, it’s easy to see that reverse mortgages are probably safer than you think. If a homeowner understands the features and stipulations going in, reverse mortgages can be a secure way to maintain your lifestyle when you retire. Before deciding on a reverse mortgage, it’s a good idea to speak with a financial professional to make sure it’s a good fit for you and your circumstances.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.