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Why Reverse Mortgages Are Not a Retirement Option

Written by Hank Coleman - 12 Comments

Everyone has seen how housing prices have taken a nosedive in most markets across America since the start of the 2008 recession. Almost $3 trillion worth of equity has disappeared, and homes are now worth significantly less than what their owners paid for them. This evaporation of equity has dealt a devastating blow to many elderly Americans who were originally planning on tapping into that equity to supplement their retirement through reverse mortgages.

The truth is that reverse mortgages shouldn’t be used as a last minute tool to fund your retirement. Unfortunately, the lack of homeowners’ equity and a host of other factors have made reverse mortgages a thing of the past as a retirement option.

What is a reverse mortgage?

A reverse mortgage is much like a standard mortgage for your home. It is called a reverse mortgage because the homeowner will receive a cash payment based on the amount of equity he or she has in their home. So, after you finally get your home mortgage paid off and you own your home free and clear, you can go back into debt again for the exact same house with a reverse mortgage.

In contrast to a conventional mortgage, however, there is no repayment requirement as long as the homeowner meets certain requirements, such as continuing to use the home as his or her primary residence. Once the borrower dies, the loan must be repaid.

Reverse mortgages require equity

One of the biggest realizations to come out of the current housing crisis is that reverse mortgages require homeowners to have equity in their homes. If you’ve been banking on a reverse mortgage to fund your retirement instead of investing for your financial goals that you should be been doing all long, you could be in for a rude awakening if the equity in your home has vanished.

This is exactly what happened during the recent (and ongoing) housing crisis, and many Baby Boomers and retirees have been left in a tough situation with little in the way of retirement savings and a hope of using home equity and a reverse mortgage to fund their retirement dreams. But, when the equity disappeared, so did their ability to borrow against their home for retirement. Traditionally, homeowners thought that home prices would rise forever, but that has proven not to be the case in recent years.

Reverse mortgages can hurt your heirs

When you borrow against your home equity to cover living expenses in retirement, you’re putting your heirs at risk of some serious estate planning consequences. When you die, your reverse mortgage must be repaid. Many estates do this either with insurance proceeds or by selling the primary home that was mortgaged. This can be devastating news to family members who may have been counting on those funds for one reason or another — e.g., daily living expenses, paying for a future college education, or paying off other debts of the deceased. Reverse mortgages also have the potential to forcing the sale of homes that have been in families for generations.

Reverse mortgages aren’t a substitute investing

When home prices in America were skyrocketing, many people skipped funding their retirement accounts in favor of buying a bigger home and paying down their mortgage. The trouble with this is that you really need to have a well-rounded financial plan that includes investing for retirement and other goals, saving, paying down debts, and protecting yourself and your family with insurance. Banking on the ability to borrow against the equity in your home during your retirement years is a very risky strategy that can blow up in your face.

Reverse mortgages are expensive

Historically, reverse mortgage are very expensive because of very high fees. These fees erode the value of what little equity you have built up in your home. Like all home loans, there is an origination fee, appraisal fees, closing costs, insurance, and a host of other fees that are tacked onto your reverse mortgage. Because of this plethora of fees, the cash payout that you receive in this depressed housing market will be even further reduced.

In the final analysis, there’s no better alternative to investing for retirement than a well-balanced portfolio of stocks, bonds, and/or mutual funds. Using your home as a way to fund your retirement dreams is fraught with potential drawbacks, and the expectation that you’ll have a ton of equity at retirement is based on the faulty assumption that your home will necessarily increase in value, or at least retain its current value.

Do you have any experience with reverse mortgages? Has your declining home value now made a reverse mortgage impossible? I’d love to hear your thoughts in the comments section.

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Published on October 27th, 2011
Modified on November 7th, 2011 - 12 Comments
Filed under: Mortgages, Retirement

About the author: Hank Coleman is a freelance writer who has written extensively for many financial websites and publications. Hank holds a Master's Degree in Finance and is actively pursuing Certified Financial Planner status.

12 Responses to “Why Reverse Mortgages Are Not a Retirement Option”

1
R S Says:
October 27th, 2011 at 11:12 am
Interesting, I always wondered what a reverse mortgage was/how it worked.

Heirs, however, should not be a consideration for not taking one out. Heirs should not be depending on an inheritance, it should be a windfall.

For the generation that is close to retirement, or recently retired, I can see how this option is something they have to consider – especially if their retirement portfolios have taken a beating. Certainly, the 20-30some crowd should not be considering a reverse mortgage as a retirement plan..

Either the heirs give back and provide financial support, if for no other reason than to protect their inheritance, or a reverse mortgage may be the only other option for some.
2
Petunia 100 Says:
October 27th, 2011 at 11:27 am
I agree that everyone should be saving/investing as the years go by and should not rely entirely on home equity to fund their retirement. However, I disagree that people should not consider how they might use their home equity to fund their needs.

Also, I strongly disagree that a reverse mortgage should not be considered since it will likely reduce inheritance. So what? People have to cover their own needs first. Would you suggest retired people avoid spending a single penny so that they can leave more to their heirs when they die? If you wouldn’t, then your advice here is inconsistent.

A reverse mortgage is merely one tool which might be used. If a reverse mortgage will improve one’s financial circumstances, then it should be considered.
3
Srinath Says:
October 27th, 2011 at 12:32 pm
I view a reverse mortgage as an easy way to liquidate my house, if I’m not planning to leave it behind. I get regular monthly payments, plus I can stay in it till I die. While it should not be the sole retirement plan, it is definitely a useful addition for some, just like Social Security.
4
Vince Thorne Says:
October 27th, 2011 at 12:59 pm
In specific cases, like Srinath above, a reverse mortgage might make sense. Say you bought a home in the 50s or 60s and are now retired with your retirement funds running out. A reverse mortgage that generates a positive cashflow will see you through the the next couple of decades might make sense. Ofcourse, you have to forego the house to the bank at the end as there is no way you will be able to have the money and the house as well. It may make sounder financial sense to sell the big home and move into a smaller home and live out retirement there.
If you are getting a reverse mortgage to fund college or buy a car I have just 2 words: Good Luck!
5
Jim Says:
October 27th, 2011 at 4:45 pm
I consider a reverse mortgage to be a last resort if you’re retirement age and having difficulty paying your bills and have no other assets. I know of one friend of my in-laws with a reverse mortgage and his equity got him a few hundred extra a month in addition to his small social security check and helped him pay the bills. He’s in his 80’s with medical issues. It worked well for him.
6
Traciatim Says:
October 28th, 2011 at 10:11 am
I have to agree with the others that your heirs should be one of the lowest priorities on your list of considerations when looking at a reverse mortgage.

Generally reversed mortgages are limited in the loan to value ratio they can lend, and it’s you’re money that you have tied up sitting there doing nothing so why not enjoy it?

Maybe instead of leaving your heirs with an empty house you could use the money to spend more time with them while you’re alive and having some great experiences together. That’s far more valuable than a pile of sticks that keeps rain off your head.
7
Beth Says:
October 29th, 2011 at 10:47 am
I began looking into reverse mortgages a few years ago…My Dad had a pension which my Mother still lives on. When Dad died the sale of the condo went to Mom so she can live in a nice assisted living facility. I don’t expect to see any of the money my father worked for,when my Mom goes.
I feel reverse mortgages are the same thing. Like my Dad I did, and still am,saving DURING my newly entered retirement. I too have a pension and am living within or below my means. That’s something many of the 20-30 somethings don’t understand.
8
Bill Says:
October 29th, 2011 at 2:13 pm
After living in my home for 4 years I re-financed and took out a reverse mortgage. I had to bring cash to the table from my previously paid off prior home but still have a lot left. But I now have no payments and my kids would not want to maintain or use this place. I figured the break even point for cash/payments/fees is 12 years. (11 to go!) I lived in my last place for 18 yrs and just love this smaller ranch with the perfect layout and neighborhood. I am very pleased with my financial plan. It does take the right circumstances but it seems to fit very well for me. I look at the situation as buying a home for half price by paying cash. If I live another 20-25 years I’m way ahead of the game and no banks to deal with….ever.
9
Disgruntled Homeowner Says:
November 14th, 2011 at 1:04 pm
Reverse Mortgage, or nothing else, will EVER work out if on one hand you have enough equity to do it, and on the other hand, you have a greedy hand ready to take half of your money. I approached the age and equity to do a Reverse Mortgage, but unfortunately housing value fell to the point of wiping out all my equity and put me under water. Greed has grown rampant in this country and all over the world. They pile on too much fees which make me not want to do a Reverse Mortgage. I should get 99% of my money, they should get 1%. Instead, they get 50%. PLEASE DON’T VOTE FOR OBAMA! Why? Because his policy did not address the problem of us elderly who are the worst victim of this housing crisis. In other words, I feel robbed of my investment (my down payment) put into my home. I am an African American and I appeal to other AA, DO NOT VOTE FOR OBAMA because he is black like you. Look beyond race. VOTE for someone you feel can get us out of this mess, who is capable of restoring our country back to the great county it USE to be. Obama is NOT capable!
10
Dan Scerpella Says:
July 13th, 2012 at 2:06 am
I have a problem with a few of the things written this article and the implications left by the author.

First of all, in a perfect pre 1980 world we all have pensions and healthcare guaranteed for our retirement. Gas and food and medical care is affordable. This is not that world. The value of our largest asset (usually) now needs to be considered fair game for funding or enhancing ones retirement income. It is not a vehicle of last resort, it is one choice among many. Retirees are living longer, retirement nest eggs are disappearing more quickly. This also means that retirees’ children are well into adulthood and don’t really need to inherit Mom and Dads home.

The author states that once a borrower dies the loan must be repaid. Is this not self evident? The impression is given that somehow this is uncommon or disadvantageous. This is standard practice for any mortgage. Mortgage debt does not disappear when the borrower passes.

That a reverse mortgage alters the future interest of one’s heirs is also self evident, and both Reverse Mortgage lenders as well as third party counselors required to proceed with the loan ensure the borrowers are completely aware of this.

The author also informs us that Reverses are expensive. To that I would ask, compared to what? The misperception was that a HECM was more expensive than a conventional mortgage because the borrower often got their costs “free” in a conventional mortgage. This is misleading because when a borrower gets those fees covered it is because the LO has given the borrower a loan with a higher rate than absolutely necessary and then paid those costs out of the back end which was increased by the higher rate. Reverses are required to express these costs up front and the responsibility of the borrower (more often than not financed as part of the loan) In fact out of pocket for the average Reverse is usually limited to the appraisal. Ultimately in both reverses and conventional the costs are borne by the borrower. If anything the Reverse disclosures are more honest about that fact. Further in the past 3 years most of the major lenders now offer Reverses with no origination fees and in some cases no FHA insurance premium, which in most cases is the largest single cost item, and this goes to the FHA not the lender.
11
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