3 potential reverse mortgage pitfalls

David  Mully
Written by
David Mully
Read Time: 3 minutes

Reverse mortgage lending can be a useful financial tool for homeowners over age 62.  But used improperly, it can cause severe financial distress for the unwary.

How does a reverse mortgage work?  It's a special type of home equity loan that allows seniors to borrow against their equity without having to make any loan payments as long as they live in the home.  The loan is eventually repaid when they vacate the property, typically with the proceeds from selling the home.reverse mortgage pitfalls

The rules of a reverse mortgage make it an attractive option for seniors on a limited income facing financial challenges. Sudden medical expenses, mounting tax bills, even ongoing living expenses can be met with a reverse mortgage.  Depending on how much home equity you have, you can even use a reverse mortgage to pay off your current home loan, possibly keeping you out of foreclosure and saving your house.  It can keep you in a dignified standard of living and close to friends and family.

One of the disadvantage of a reverse mortgage is that they're  basically a no doc loan, meaning a person does not have to provide any documentation (income, medical bills, etc.) that would demonstrate a need. If a person is persistent enough, they can probably find reverse mortgage lenders who will take their application.

On the other hand, reverse mortgage rules do require that applicants undergo credit counseling beforehand, which can alert borrowers to potential reverse mortgage pitfalls and help them decide whether a reverse mortgage is the right choice for them or whether other options might be better.

"We do a lot of counseling," says Don Girogio, the president of United Northern Mortgage Brokers. "And within our counseling, if we feel like someone shouldn't be doing a reverse mortgage, we won't take the application. It's not for us to judge them, but at the same time, we're not going to be part of a situation that could potentially wipe them out."

As a rule, you should only resort to a reverse mortgage for essential expenses. Here are three examples of reverse mortgage pitfalls that can get you in trouble .

1) You are getting by but want more money: If you have enough money to live on and your bills are paid, you probably don't need a reverse mortgage. If you just want extra spending money, you should ask yourself if you would use the money for constructive purposes or would it be for wants instead of needs? While you don't need to make any payments on a reverse mortgage as long as you live in the home, you may need that equity later on should you leave the home to enter assisted living.

2) You want to make an investment: Taking out a reverse mortgage to make an investment may be a temptation. But your home is also an investment, and a major asset as well – it gives you a roof over your head. And money invested can also be lost. It's not worth it to risk your home equity on an investment that could very well wipe you out.

3) You want to give the money to family members: It's nice to be able to give financial assistance to family members when they need it. However, if you need to take out a reverse mortgage to do it, then you may be the one who is actually in need. Don't let anyone pressure you into whittling away the equity in your home. If they need it that badly, they'll find another way. Draining away your home equity is just going to make things more difficult for you down the road.

A reverse mortgage should be treated as an insurance policy or reserve funds. You never know what may happen a few years down the road and you could finding yourself wishing you have that home equity to draw against. 

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