Reverse Mortgage Disadvantages

Reverse mortgages have several disadvantages alongside a cornucopia of advantages. Before you consider a reverse mortgage, definitely take the time to inform yourself of the reverse mortgage disadvantages that can leave you broke. We’ll explore the downsides below.

Losing Equity
Of all the disadvantages, the slow loss of homeowners equity that results from a reverse mortgage is, by far, the most painful. When you go to extract home equity from a reverse mortgage on your property, a loan is tallied against your home with each passing year. As you know, the loan amount is distributed to you in the form of a monthly payment, which does provide some cash flow in retirement.

However, realize that the interest rate on your reverse mortgage may be greater than the change in housing prices. If your reverse mortgage costs 5% per year, then the debt accrued against your home’s value is growing at 5%, as well. This can be especially damaging to your finances, as each disbursement and subsequent interest charge essentially transfers more value in your home from you to your lender.

Cash flow risk
Reverse mortgages also tie a considerable amount of risk to your post-retirement cash flow. If the value of your home were to drop by 20%, for example, then your home equity would decline by the same amount or more. When your home equity declines in value, then the amount you can potentially borrow declines as well.

In the event of a falling housing market, realize that the total amount of money you can extract from your mortgage drops as well. You may have planned for 5 years of reverse mortgage proceeds, but a small decline in housing prices means that you’ll only be able to borrow for 3 years, leaving you out of luck for the 2 years of payments you came to rely on.

Update: While an initial appraisal establishes the line of credit size, a reverse mortgage line of credit cannot be reduced based on current home values. (Credit to National Reverse Mortgage Lenders Association)

Upside limitation
Whereas falling prices mean you can borrow less money in a reverse mortgage, rising prices don’t necessarily mean that you can borrow more. A big reverse mortgage disadvantage is that the contract will split the upside in the home between you and your bank. The upside may be split 50-50 between you and your lender, negotiated so that the upside is split proportionally by the amount of home equity, or split in such a way that the appreciation beyond a certain percentage rate is the bank’s to keep. Many people enter into a reverse mortgage thinking that owning the home means that the upside is theirs as well, and this simply isn’t the case.

Update: Home Equity Conversion Mortgages (HECM) rules prohibit sharing upside equity as part of a reverse mortgage. In fact, equity share has been gone from the reverse mortgage industry for over 10 years. (Credit to National Reverse Mortgage Lenders Association)

Taxes and Insurance
Even though you’re slowly selling your home in a reverse mortgages, the property tax charges and insurance payments are still yours to pay. Failure to pay on the insurance costs means that a bank may step in to pay them for you, deducting this amount from your monthly payments. On the other hand, a bank may issue an eviction notice as part of the contract. The property taxes play an important part in the eviction process as well, as you still have to pay property taxes on the home as if you owned it 100% outright, and no loans were due.

Property taxes and insurance costs are difficult to forecast. For one, insurance companies adjust their risk models routinely so as to defend themselves against higher than average claims resulting from property damage, theft, or natural disasters. Additionally, a state or local government can decide on a whim to increase property taxes to balance their budgets. An increase from 1 to 2 percent of a property’s value on a home worth $100,000 would be an additional $80 monthly expense, which is enough to force many seniors and retired couples to make difficult decisions.