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In Southern Arizona
Reverse Mortgages: BBB Offers Pros and Cons
June 16, 2008

A reverse mortgage is a popular, but complex, home loan just for senior homeowners. If you qualify for a reverse mortgage, you will not have to make monthly payments on the loan. Instead, the lender pays you. Typically, the loan is repaid from your home’s equity when you sell the home, move out permanently, or die. You, or those who will inherit from you, can keep any sales proceeds from your home in excess of what you owe the lender.

To qualify for a reverse mortgage, you must be a homeowner who is at least 62 years old. The mortgage on your home must be fully or nearly paid off. Generally, the amount you can borrow depends on the value of your home, the amount of equity you have in the home, and your age at the time of loan application.

But is taking out a reverse mortgage right for you? BBB suggests you look beyond the advertising of these financial products, consult your family, and talk with independent financial advisors who would not benefit from the transaction and consider the following pros and cons:

Reverse Mortgage Pros
· You can remain in your own home and retain ownership
· You do not need an income to qualify
· The money you receive from the loan is tax-free
· You do not have to make monthly payments
· You can tap into your home equity to improve the quality of your life
· You can realize more financial independence in the short term

Reverse Mortgage Cons
· Loan costs can be substantial
· Fees earned by mortgage brokers are high
· Reverse mortgages are more costly to set up than other types of loans
· Advertising hype may not help you determine whether the loan is right for your circumstance, and likely understates the long-term costs
· Interest and fees are added to your debt
· Costs are higher for younger seniors (i.e., age 62; the loans should be considered a last resort if you appear poised to outlive your savings)

AARP (www.aarp.org) offers additional advice for seniors considering a reverse mortgage:

A reverse mortgage may be right for you if:

  • you have a regular need for additional living funds;
  • you live on a fixed income, and your only asset is your home equity;
  • you do not plan to leave your home to your children or others who will inherit from you.

Consider alternatives to a reverse mortgage if:

  • you want to leave your home, free and clear, to your children or others who will inherit from you;
  • you have another, less costly means to reach your financial goal; a reverse mortgage can be an expensive way to borrow money.

Use this list of shopping questions:

  • How much money do I need?
  • Is there a way to meet my needs that does not involve getting a reverse mortgage?
  • Will a reverse mortgage make my partner or me ineligible for any government benefits, currently or in the future?
  • Do I qualify for this reverse mortgage?
  • How much can I borrow through a particular reverse mortgage product?
  • How much will it cost me in fees and interest to borrow this money even if I don’t have any "out of pocket" expenses?
  • Will I have to sell my house before I die to pay off this reverse mortgage?
  • What happens if I die, and my partner is still alive and living in the home; will he or she have to leave or pay the loan off?
  • What happens if I have to go to a nursing home; how soon will the loan become due and payable?
  • What will I or my heirs have left after the loan is paid off?
  • Are there any early-repayment penalties?
  • What are my obligations under the reverse mortgage, such as home maintenance, property taxes and insurance?

A "reverse" mortgage is a loan against your home that you do not have to pay back for as long as you live there. With a reverse mortgage, you can turn the value of your home into cash without having to move or to repay the loan each month. The cash you get from a reverse mortgage can be paid to you in several ways:

  • all at once, in a single lump sum of cash;
  • as a regular monthly cash advance;
  • as a "creditline" account that lets you decide when and how much of your available cash is paid to you; or
  • as a combination of these payment methods.

No matter how this loan is paid out to you, you typically don't have to pay anything back until you die, sell your home, or permanently move out of your home. To be eligible for most reverse mortgages, you must own your home and be 62 years of age or older.

You can see how a reverse mortgage works by comparing it to a "forward" mortgage — the kind you use to buy a home. Both types of mortgages create debt against your home. And both affect how much equity or ownership value you have in your home. But they do so in opposite ways.

"Debt" is the amount of money you owe a lender. It includes cash advances made to you or for your benefit, plus interest. "Home equity" means the value of your home (what it would sell for) minus any debt against it. For example, if your home is worth $150,000 and you still owe $30,000 on your mortgage, your home equity is $120,000.

When you purchased your home, you probably made a small down payment and borrowed the rest of the money you needed to buy it. Then you paid back your traditional "forward" mortgage loan every month over many years. During that time:

  • your debt decreased; and
  • your home equity increased.

As you made each repayment, the amount you owed (your debt or "loan balance") grew smaller. But your ownership value (your "equity") grew larger. If you eventually made a final mortgage payment, you then owed nothing, and your home equity equaled the value of your home. In short, your forward mortgage was a "falling debt, rising equity" arrangement.

Reverse mortgages have a different purpose than forward mortgages do. With a forward mortgage, you use your income to repay debt, and this builds up equity in your home. But with a reverse mortgage, you are taking the equity out in cash. So with a reverse mortgage:

  • your debt increases; and
  • your home equity decreases.

It's just the opposite, or reverse, of a forward mortgage. With a reverse mortgage, the lender sends you cash, and you make no repayments. So the amount you owe (your debt) gets larger as you get more and more cash and more interest is added to your loan balance. As your debt grows, your equity shrinks, unless your home's value is growing at a high rate.

When a reverse mortgage becomes due and payable, you may owe a lot of money and your equity may be very small. If you have the loan for a long time, or if your home's value decreases, there may not be any equity left at the end of the loan.

In short, a reverse mortgage is a "rising debt, falling equity" arrangement. But that is exactly what informed reverse mortgage borrowers want: to "spend down" their home equity while they live in their homes, without having to make monthly loan repayments. However, most home values don't grow at consistently high rates, and interest is charged on most mortgages. So the majority of reverse mortgages end up being "rising debt, falling equity" loans.