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Monday, March 7, 2011

Disadvantages of a reverse mortgage

A reverse mortgage or home equity conversion mortgage provides mortgagees with cash payment using the equity of a home. These mortgages have the effect of an additional source of income to retirees looking to increase their monthly or annual income. Although there are advantages with this type of mortgae, it is important to be aware of the dasdvantages before deciding if it is the right financial choice.

The disadvantages of reverse mortgages aren't always consistently applicable to all mortgagees. Since reverse mortgages are crafty yet worldly-wise financial instruments that may or may not be the best retirement income opportunity for you, a good understanding of them is useful when weighing your financial choices. Several disadvantages of reverse mortgages are illustrated in the video and text that follow.

Depending on the conditions within the housing market and your personal circumstances a reverse mortgage also has potential disadvantages that may not exist at the time of origination. Specifically, if the income provided by a reverse mortgage is essential, and for some reason you have to leave your home, that income may vanish as a requirement of reverse mortgages is for them to be paid after leaving the home.

Valuation and interest rate risk

Another disadvantage of reverse mortgage is valuation and interest rate risk. Although the two tend to have an inverse relationship,  if the housing market is experiencing slow sales, low construction levels, and high foreclosures the prospect of price appreciation dims and a larger reverse payout reduced. Even if the reverse mortgage is refinanced at a higher amount in the future, most of the costs of the original reverse mortgage are duplicated in the refinance.

Costs of reverse mortgages

The costs of reverse mortgages are also a disadvantage as origination of the loan run into multiple thousands of dollars. According to the Reverse Mortgage Lenders Association (RMLA), the costs of a reverse mortgage include a two percent origination fee for the first $200,000 and one percent thereafter, an additional two percent mortgage insurance fee, closing costs, appraisal fee and loan servicing fees. So for example, a $190,000 reverse mortgage would cost as much as $8,000-$10,000 to originate.

Qualifying for a reverse mortgage

Qualification for reverse mortgages isn't always a shoe in either. Typically a high ratio of equity to debt should be present to qualify for and acquire the most loan from the property and even then the income may not be as advantageous as other financial strategies such as downsizing the home and reinvesting the surplus capital for another type of income stream that isn't from a reverse mortgage loan.

Reverse mortgage terms may not be flexible either. If you haven't paid your property tax, mortgage or real estate insurance, or don't meet home maintenance requirements the mortgage may be called in. This could pose a significant problem for tenured reverse mortgages with lifetime income streams. In light of this, being fully aware of the terms of the mortgage prior to origination is a good idea.

Lastly, if you are planning on having a large estate for a charitable foundation or any other number of reasons, reverse mortgages might be a disadvantage to you due to their net worth depreciating effect. Serious health problems can also be a disadvantage in reverse mortgages.  For example, if your health requires relocation into a location other than your home, the terms of the mortgage can require the home to be liquidated and reverse mortgage income to expire. If this scenario hasn't been accounted for in advance it could  pose a significant disadvantage to the financial practicality of a reverse mortgage.


1. http://bit.ly/dqrKFD (Reverse Mortgage Lenders Association)
2. http://bit.ly/YcRvH  (Federal Trade Commission)
3. http://bit.ly/owKrR  (Department of Housing and Urban Development)
4. http://aarp.us/bJ8Q3K(American Association of Retired Persons)
5. http://bit.ly/d75ktu (Washington State Department of Financial Institutions)

1 comment:

  1. Disadvantages of reverse mortgages include the required fees to setup and maintain a reverse mortgage, which can be higher than other types of home loans, as well as the compounded interest that is due when the loan needs to be repaid. Sometimes a home must be sold when the homeowner dies in order to repay a reverse mortgage, although the heirs may choose to refinance the loan or use other assets in order to retain ownership of the home. Any proceeds from the sale of the home that are over the amount owed on the reverse mortgage remain part of the homeowner’s estate. If the heirs choose to keep the home and they can come up with the funds needed to pay off the reverse mortgage in full, however, they are not required to sell the home.