Are Reverse Mortgages Too Expensive?
Reverse mortgages are increasingly popular because the senior citizen population is growing faster than any other demographic group in the country. But some critics argue that reverse mortgages cost too much to make them a suitable retirement planning vehicle.
Reverse mortgages are a special type of loan that allows older homeowners, age 62 and above, to borrow against their accumulated home equity. The homeowner doesn't make loan payments; instead he or she receives cash from the lender in exchange for a stake in the value of the home.
Seniors can choose to receive their money in a variety of ways; a lump sum, monthly installments, a line of credit or a combination of means and methods. Because the homeowner isn't required to make loan payments, there are no minimum income requirements like those associated with traditional mortgages.
Reverse mortgages are designed to be repaid by selling the home when the borrower eventually dies or otherwise vacates the property. Any leftover money goes to the borrower or his/her estate.
Baby boomers and reverse mortgages
Baby Boomers – generally defined as those born from 1946-64 – make up about 30 percent of the U.S. population. There are 78 million Americans in this demographic, and the first of them turned 65 in 2011, representing the largest-ever segment of American society to hit retirement age. That means all the homeowners among them are or will soon be candidates for a reverse mortgage.
Companies are heavily marketing reverse mortgages to them in order to take advantage of that. But critics say the loans offered by many reverse mortgage lenders are prohibitively expensive. That's largely because, as the homeowner avoids making loan payments, the mortgage interest and fees are steadily tacked onto the loan balance, growing larger and larger over time.
Because reverse mortgages are open-ended – there's no fixed date when they have to be paid off – those interest charges and fees can accumulate to be quite large by the time the borrower dies or otherwise vacates the property.
Reverse mortgage rates may be low compared to other mortgage rates, but because of the way the interest is compounded, they become expensive over time. Then there are the other costs involved in setting up a reverse mortgage. Borrowers often have to pay origination and appraisal fees, the cost of a title search, and additional mortgage insurance premiums.
Fortunately, your fees are capped if you get an FHA-backed Home Equity Conversion Mortgage (HECM), which is the most common type of reverse mortgage. With a HECM, your origination fees can be no higher than 2 percent of the loan amount up to the first $200,000, and 1 percent on anything after that, to a maximum of $6,000.
Alternatives to reverse mortgages
Although a reverse mortgage is designed to be repaid by selling the home when the borrower(s) no longer needs it, they may still have need of the equity it represents. Nursing home or other extended care costs are one possibility. Other borrowers may wish to leave an inheritance for their family.
A regular home equity loan or line of credit (HELOC) may be a more appropriate strategy for some homeowners. The AARP notes that home equity loans and HELOCs are less expensive if the homeowner has enough income to manage the monthly payments.
Another possibility would be selling the home, moving into a less expensive one and banking the difference or investing it to provide income.
For those who at an advanced age, the cumulative effect of reverse mortgage rates and fees may be a less important consideration if they do not expect to be in the home for a period of many years.
Choices regarding the financial sense of a reverse mortgage need to be made on an individual case-by-case basis. Seniors should carefully review their situation and financial options making any decisions.