The Truth about Reverse Mortgages

“A reverse mortgage has its benefits, but it’s an expensive way to borrow money and not without risks.” — John Schaub, author, “Building Wealth One House at a Time” (2nd edition)

Like you, I’ve seen a lot of ads promoted by prominent TV personalities, such as Henry Winkler (“Happy Days”), Tom Selleck (“Blue Bloods”) and Alex Trebek (“Jeopardy!”), encouraging you to get a “reverse mortgage.”

Essentially, a reverse mortgage is a special kind of home equity loan that replaces your traditional mortgage. The new loan pays off your first mortgage, and creates a new, bigger loan. Interest rates can be fixed or variable. You can take the money in a lump sum, a steady stream of monthly advances or a line of credit. The funds from the reverse mortgage are tax free — you don’t have to pay income taxes on borrowed funds. The key is that you don’t have to pay off the principal and interest like you normally do unless you sell the house or move out. In fact, the borrower (you) has no personal liability if the loan exceeds the value of the house at some point.

So how does the bank get paid? One possibility is that the mortgage lender resells the reverse mortgage after capturing the origination fee. Alternatively, if the mortgage lender holds onto it, heirs may be asked to pay back the entire loan plus interest upon the death of the mortgage holder, or the bank can sell the house and get its money back.

It all sounds pretty good, especially for retirees who are strapped for money and would like to tap the equity in their home.

What are the limits and pitfalls?

You have to be at least 62 years old to qualify for this Federal Housing Administration (FHA)-insured loan (officially called a “Home Equity Conversion Mortgage”). You need to have equity in the house, where the appraised value of the house is more than the first mortgage. Closing costs do apply and include appraisal fees, title insurance and high origination fees (many banks will finance the closing costs so out-of-pocket expenses can be minimal).

The costs of a reverse mortgage are higher than those of a standard mortgage. Interest rates on the reverse mortgage are slightly higher than traditional mortgages as well, and there’s a 1.25% annual fee for the mortgage insurance premium imposed by the FHA.

As the homeowner, you will have to continue to pay real estate taxes, insurance and maintenance costs on the house. If you run out of money, the lender may foreclose on you.

The biggest headache for a reverse mortgage may be when you die or decide to sell or move out of your primary residence. John Schaub, my real estate expert and author of the bestseller book “Building Wealth One House at Time,” says that he has received several distraught calls recently from heirs who have inherited houses encumbered with reverse mortgages that become payable at the death of the borrower.