If you're an older homeowner looking to tap into your home equity to free up some cash, a reverse mortgage may sound like a great idea. While reverse mortgages have some great features, they're not a smart choice for all homeowners. The truth is, they come with some big risks that you should think about before taking the plunge.
The guide published by the Consumer Financial Protection Bureau (CFPB) details the following risks.
1. If you move out for more than a few months, you could lose your home
The home you use to get a reverse mortgage must be your principal residence. If you live in your home year round, you currently meet this requirement. But if you're ever away from your home for the majority of a year for non-medical reasons, or if you move into a healthcare facility for 12 consecutive months or longer, your reverse mortgage could become repayable. If you don’t have cash to repay it, you'd potentially have to sell your home, and you and anyone else who lived with you would have to move out.
2. If you're married and you die before your spouse, your spouse might have to move out of your home
If you're married and get a reverse mortgage without your spouse as a co-borrower and you die before your spouse does, some special rules apply. These rules are intended to protect non-borrower spouses from having to move out of their home when the borrower dies, but the rules don't protect every spouse in every situation. Spouses who don't fit the criteria will have to move out of the home.
3. If you leave your home to your kids, they'll probably have to sell it to repay your reverse mortgage
"A reverse mortgage is not free money," the CFPB guide explains. "It is a loan that you, or your heirs, will eventually have to pay back, usually by selling your home."
To repay your loan, your heirs can:
- use cash (e.g., personal savings or inheritance).
- refinance, if they can qualify for a new loan.
- sell the home and use the proceeds to pay the loan.
If the loan balance is more than the home's worth, your heirs will have to repay 95% of the appraised value.
4. Your reverse mortgage will eat your equity.
Like other types of home loans, reverse mortgages involve upfront and monthly costs and interest expenses.
Costs can include lender's fees, closing costs, servicing fees, and mortgage insurance premiums. Interest is charged monthly.
Fees and interest normally aren't paid out of pocket, but instead are added to your loan balance. But because you don’t make monthly payments, your loan balance increases over time.
5. You'll still have to pay property taxes, homeowners insurance, and take care of maintenance and repairs
A reverse mortgage allows you to cash out equity without making payments. But that doesn't mean you can live for free.
"Although you won't make monthly mortgage payments, you'll need to continue to pay property taxes and homeowner's insurance, and keep your house in good condition," the guide explains.
If you don't comply with those rules, your reverse mortgage could become repayable. If you don't have cash to repay it, you'll have to sell your home. If you owe more than your home is worth, you'll still have to pay 95% of the appraised value.
It should be noted that this information applies to Home Equity Conversion Mortgages, or HECMs. Virtually all reverse mortgages today are HECMs, but the rules may be different for non-HECM reverse mortgages.
If these drawbacks give you pause — and they should — you might want to consider alternatives to a reverse mortgage that can also help you turn your equity into cash.