Reverse Mortgages Pros and Cons

Individuals aged 62 years or older who own a piece of property and occupy it as their residential home are eligible to take a reverse mortgage on this property. The repayment of the loan is deferred until that individual’s death or until the property is sold. The borrower is not required to make any payments at all for the mortgage, but the interest accumulating on the mortgage is added to a lien on the property. The amount of the mortgage is usually tagged to the current value of the property (based on its location and value) and therefore, the possibility of getting a high reverse mortgage is usually good. There are no minimum income requirements because, for the duration of the life of the borrower, no repayment is required. But before you rush out to the bank, remember that interest is accumulating and this is being attached to the property.

This is not to say that it is a free-for-all scheme. Applicants are required to take a Federal Housing Authority approved counseling class and must present the certification of completion of this program as proof before being eligible to apply for a reverse mortgage. This is to ensure that individuals interested in reverse mortgaging are fully aware of the impact of their loan on them, and the potential beneficiaries of their property.

What determines eligibility for reverse mortgages?
The amount of the reverse mortgage loan is determined by, firstly, the age of the applicant. The structure works on the basis that the older the applicant is, the higher the mortgage amount. The second is the appraised value of the property and whether there are any existing encumbrances such as an earlier unsettled mortgage. Thirdly, the current interest rate is relevant. Finally, it is also relevant whether the reverse mortgage amount will be taken in one lump sum or whether the applicant opts to take it as monthly withdrawals. For the former, the rates of interest will obviously be higher, but the latter may be a good way to go if the applicant is interested in a fixed monthly income for the rest of his or her life. A peripheral issue, but one of importance, is that the applicant must ensure that all taxes and insurance payments are current in order to avoid the reverse mortgage being treated as defaulted.

Key advantages and disadvantages
The obvious disadvantage is that the cost of getting such a mortgage is usually higher although almost all these costs are absorbed into the mortgage itself, therefore, the borrower will not have to make any initial payments, except to get the property appraised. The good news (if this matters at all to the applicant realistically) is that the rates of interest tend to be more competitive.

Another advantage is that when the borrower dies, sells the property, or is no longer living in the home for more than 12 months, the loan becomes due. This does not automatically mean that the lender has rights over the property. Interestingly, should any of these events arise, the borrower or his estate will have the option of either refinancing the home and keeping it (the money from the refinancing will be used to pay off the reverse mortgage); selling the home, repaying the reverse mortgage and keeping the difference; or surrendering the home to the lender, in which case the borrower and his successors will have no further claim over the property.

Individuals interested in exploring reverse mortgages as an option to raise funds for whatever reason should ensure that they are properly educated about the implications of such a mortgage. Whilst the requirement of attendance on the FHA counseling program does make a difference, in practical terms, applicants should obtain independent advice from legal professionals and even financial institutions before making such a decision.

One of the key things that the borrower may not realize is that since these reverse mortgages are not serviced by monthly installments, the interest that accrues can be very high, as it works on a compound interest model. Therefore, there is a very real risk that the reverse mortgage may essentially eat into the value of the property just on interest alone, and this is clearly a disadvantage. The back-to-back advantage is that the government regulates these mortgages, and the rule of thumb is that the borrower can never owe more than the value of the property and that the debt cannot be passed to the borrower’s heirs.