Offering a way to tap equity and improve cash flow, a reverse mortgage can be a great option for many homeowners with many upsides. But as with all major financial transactions, it’s important to fully understand how these mortgages work and how they will impact your finances. Before deciding whether a reverse mortgage is right for you, here are a few potential downsides to be aware of.
Heirs May Not Be Able to Keep the House
Reverse mortgages are nonrecourse, meaning the borrower or their heirs will never owe more than the home’s market value when it is sold to repay the loan. Heirs can pay back the loan with a new mortgage or by some other method, but in most cases, heirs sell the home to pay back the loan.
Though your heirs may not keep your home, they will receive any home sale proceeds that exceed the loan balance. They can also inherit any other assets you specify, like jewelry, property, or cash.
You May Pay Higher Interest and Fees
Unlike a traditional mortgage in which the borrower pays a percentage of interest and the loan balance each month, reverse mortgage interest is compounded. It must be paid off all at once when the loan becomes due and payable when the last borrower dies, otherwise leaves the property or fails to uphold the terms of the loan. Interest rates on reverse mortgages may be higher than rates on conventional mortgages. They are also more likely to be variable. It is not possible to say, going into a reverse mortgage, how much interest you will pay over the course of the loan. Because these loans do not have a specific term, that number can only be calculated when the loan comes due.
To take a reverse mortgage you will be required to pay a variety of fees including origination fees, as well as fees for mandatory HECM counseling, upfront mortgage insurance premium for HECMs, appraisals, title fees such as title insurance and searches, surveys, inspections, recording, mortgage taxes, credit checks, and other miscellaneous items. The mandatory third-party counseling and appraisal fees must be paid upfront and cannot be rolled into the loan. Other fees are typically paid out of loan proceeds. For HECMs, you will also be required to pay annual mortgage insurance premiums.
You Hold Less Equity in Your Home
In a conventional mortgage, you build equity in your home as you make payments on the principal. Your equity in the home grows over the course of the loan.
In a reverse mortgage, you exchange a share of your equity for the availability of funds and the ability to continue living in your home without making mortgage payments. The loan balance grows over time as interest and fees are added to the loan balance and compound. Depending on the amount you borrow, your equity in the home can decrease over time. However, it’s not a simple equation, and the home’s market value also impacts your equity.
You Will Still Have Housing-Related Expenses
While a reverse mortgage does eliminate mandatory mortgage payments, borrowers are still required to maintain the property, which often includes making repairs as part of the lender’s approval process. After obtaining a reverse mortgage, the loan may become due and payabl if you cannot maintain the homee, meaning it will need to be paid back.
In addition to maintaining their homes, borrowers must pay property taxes, insurance, and home association fees. If you default on any of these items, the lender may accelerate the entire loan payment on the home.
A borrower’s ability to meet these obligations is considered in the financial assessment that is part of taking out a reverse mortgage. However, if you are struggling financially, it is important to understand that while a reverse mortgage can offer some relief, it will not fully eliminate housing-related expenses.
There is No Tax Deduction
In a conventional mortgage, the Internal Revenue Service allows you to take a tax deduction for the mortgage interest you pay annually.
With a reverse mortgage, you cannot take an annual tax deduction for mortgage interest until the interest is paid. Typically, this does not happen until the loan is paid in full. Regardless, It’s important to consult a tax professional for advice specific to your situation.
It’s also worth noting that while you won’t be able to deduct interest with a reverse mortgage, you also won’t pay income taxes on the money you take out.
A reverse mortgage can be a powerful financial tool that provides many benefits, but borrowers need to understand the potential reverse mortgage downsides. It’s a good idea to speak with a financial advisor to assess the pros and cons to determine if a reverse mortgage is right for you.
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.