The Wise and the Wary
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Reverse Mortgages: The Cons
Let’s talk dollars
By far the biggest downside of reverse mortgages is the high cost imposed on the senior. Front-load fees, closing costs, and mortgage insurance may eat up 7% to 10% of the home’s value. Recent federal law has eased this burden somewhat, capping origination fees at 2% for the first $200,000 and 1% on any amount over that, with a total cap of $6,000.
In addition to paying property tax and casualty insurance, the senior must also buy mortgage insurance to cover any losses that the lender may incur. This premium is generally 2% of the loan value, payable at closing, as well as an ongoing monthly charge of 0.5% of the ever-expanding loan balance. Remember that, upon moving out or upon death, the reverse mortgage balance or the fair market value of the home, whichever is less, is owed to the lender. The mortgage balance is continually increasing since interest charges are applied every month. If housing prices continue to decline, the lender’s exposure to risk increases because the house may eventually be worth a lot less than the loan balance.
In addition, reverse mortgage interest rates are higher than conventional mortgage interest rates. I could not access any current quotes without exposing my contact information to brokers, but as of this writing (late September 2009), the national average for a fixed-rate 15-year conventional mortgage is 4.67%. If interest rates and inflation increase in the future, as many experts predict, this fixed-rate payment is a much better deal than an ever-increasing variable rate on a reverse mortgage. Seniors would be better off trying to qualify for a refinance to ease their cash flow burden.
A reverse mortgage results in a steady depletion of your net worth, shrinking your estate for your heirs. A reverse mortgage may also affect your Medicaid eligibility, since you are converting an exempt asset, your home equity, into a nonexempt asset, the cash from the loan. You will need to “spend down” your nonexempt assets to qualify for Medicaid assistance.
Stay tuned. In next week's posting, we'll cover the last major drawback to reverse mortgages.
By Deborah Hoskins, JD, CFP
The Wise and the Wary Blog
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