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Disadvantages of a Reverse Mortgage

Disadvantages of a Reverse Mortgage

Although reverse mortgages can provide a steady source of income at an old age, they come with their own set of disadvantages. Read further a brief insight into this concept and its drawbacks.
WealthHow Staff
Last Updated: Sep 14, 2018
As the name suggests, reverse mortgage (also known as conversion mortgage) is the opposite or mirror image of the conventional type. Here, instead of the borrower repaying the mortgage for the house that he buys, the house subsidizes it, which is paid to the homeowner by a financial institution.
To explain it in simpler terms, the homeowner receives a loan on his house, and the financial institution gets its money and the interest back, when the property is sold once the homeowner or the surviving spouse dies.
With the help of this loan, owners who are 'house rich but cash poor' can have the luxury of living in their own houses and still meet all their financial obligations. For a homeowner to qualify for it, he has to be at least 62 years and must have paid all or most of the home mortgage, if any on the house.
The factors that are not taken into consideration are the income and medical histories, and no medical tests are performed. In some cases, it is mandatory to undergo independent government-approved counseling. The amount that can be borrowed depends on:
  • Age of the homeowner
  • The rate of interest
  • Equity of the homeowner in the house
  • The value of the house
Both Government agencies and independent financial institutions provide these mortgages. The money to the homeowner can be paid as a lump sum in equated monthly installments, or via a line of credit. A homeowner may even choose to avail a combination of all three modes of payment.
Drawbacks
If you are considering it, then it is very important to understand the working of the loan and your responsibilities and rights, because the investment of your life - your house - is at stake. The drawbacks are:

✦ There are so many options for reverse mortgages; that may confuse the homeowner. Counseling is a must if you are considering one on your house.
✦ The entire process of availing a home loan is expensive. The costs include application fees, closing costs, appraisal fees, insurance, credit report fees, and in some cases, a monthly service fee. Further, even if it allows a homeowner to reside in the comfort of their own house, they are still responsible for all property taxes, repairs, and insurance.
If these payments are not maintained regularly, then the loan may be revoked, and the entire loan could become due in full. Although there is an option of rolling the costs into the loan amount, the cost of this mortgage can be a few thousand dollars more than the conventional one.
✦ The loan that you avail through this method is tax free. However, it may affect your eligibility for federal or state assistance, including Medicaid, Supplemental Social Security Income (SSI), and Medi-Cal benefits. Further, the interest on it is not deductible under income tax only till the loan is paid off in part or fully.
✦ It is very essential that you understand that the money, which you will be availing as a loan, will be the same that you could have left for your children as an inheritance. Hence, these should be availed only in dire consequences, or if you have no one to leave your house to.
✦ It is also important that you understand that in order to reduce risk and liabilities, mortgage companies evaluate your houses at a cost, which is comparatively higher than its actual cost. You need to decide whether taking a mortgage will be a better option or selling your house.
✦ The last piece of advice is for children of parents who are not sound due to old age or diseases like Alzheimer. The concept of owning a lot of money can give a rush, and the money may sadly be wasted.
To conclude, they have a long list of disadvantages but have their own advantages too, especially if you do not have dependents and children and want to lead the remaining of your life in luxury.
But, if you do decide to avail the loan, talk to the counselors and gather all possible information. Discuss the entire deal with your family, friends, and if possible, a financial adviser, too. Weigh out any other better alternatives if available, and make a sound decision accordingly.