Any complex financial transaction involves a certain level of risk, and reverse mortgages are no different. However, due to stringent regulations and government backing, reverse mortgages are much safer than many people believe. Here is a look at the potential risks of a reverse mortgage and the actual likelihood of each.
Your Children Won’t Inherit Your Home
Probability: Likely
Whether a reverse mortgage borrower’s children inherit the home depends on many factors. The size of the mortgage and the estate, the children’s, and the borrower’s wishes all figure in to the outcome. Many borrowers who don’t wish to pass the home to heirs don’t consider this a risk.
It’s important for borrowers bequeathing their home to understand the loan will come due when the last borrower dies. At this time the loan will need to be paid. In many cases, the heirs pay the loan by selling the home. That is a common scenario, but it is not the only one. Heirs who wish to keep the home may choose to settle the loan through their own funding. If they are over 62, they may even be able to refinance into a new reverse mortgage.
Everyone’s financial situation is different. If you wish to leave home to your children, it is worth discussing with a financial advisor in advance. They can advise on ways your children might settle the mortgage without selling the home when the time comes.
You Will Lose Your Home
Probability: Unlikely
Though it is possible to lose a home with a reverse mortgage, it is rare. Because borrowers do not make required monthly mortgage payments, the only real way to default is by falling behind on other obligations like property taxes, homeowners’ insurance, or by failing to maintain the property.
The reverse mortgage process has multiple guardrails to help ensure that borrowers understand their loan obligations and can afford them.
Mandatory counseling ensures that borrowers understand their loan obligations. A financial assessment conducted by the lender provides that borrowers are financially able to meet them. Borrowers whose financial situation doesn’t pass the financial assessment may qualify for a LESA or Life Expectancy Set Aside. That is a special fund set aside from proceeds that covers a borrower’s property tax and insurance obligations.
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Surprise FeesWill Catch You Off-guard
Probability: Low
Like any loan, there are fees and costs attached to a reverse mortgage. But unlike many loans, the process for taking a reverse mortgage has borrower education built in. All (HECM) borrowers must attend reverse mortgage counseling with a HUD-approved third-party counselor before applying for a loan.
The purpose of the counseling is to outline fees and interest, and other possible financing options. The counsellor will also cover what causes a default and how the repayment process occurs. In the counseling session, the borrower receives all documentation to review and has ample opportunity to ask questions.
You Will Outlive Your Mortgage Proceeds
Probability: Medium
Borrowers can outlive reverse mortgage by withdrawing them too soon or failing to plan adequately. However, while they may have used or outlived available funds, the mortgage does not come due unless the borrower fails to uphold the loan’s obligations.
Regulations are in place to mitigate the risk of borrowers using the money too fast. Home equity conversion mortgages (HECMs) are subject to a 60% utilization rule. This rule states that in the first year of the loan, borrowers may only receive the higher of 60% of the available funds or the amount of mandatory loan obligations (such as paying off an existing mortgage lien) +10%.
Reverse mortgage borrowers also have access to multiple ways of receiving their funds. These options can be helpful in strategizing to make proceeds last longer.
You Will Owe More Than the Home Is Worth
Probability: None
This is more a fear than an actual risk because reverse mortgages are non-recourse loans. That means neither the borrower nor their heirs will ever owe more than the property’s appraised value when the loan comes due. It is possible for the loan balance to exceed the value of the home. However, borrowers or heirs will not be held responsible for the difference.
Conversely, if the home’s value exceeds the loan balance, the seller will receive all remaining funds after the loan balance has been paid.
Before taking any loan it’s important to understand your risk exposure. It’s also wise to consult with a financial advisor to assess your specific situation.
Seniority is published by Finance of America Reverse LLC. The views expressed in this publication are those of the author alone and do not necessarily reflect the views and opinions of Finance of America Companies. 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.
