If an older cash-challenged client wants to borrow funds to buy their spouse out of the home, they are often told that if they use a reverse mortgage they’ll never have to make a mortgage payment again.
Here’s how it works: A reverse mortgage converts equity into cash, as a one-time payout, ongoing monthly payments or a line of credit to be tapped at will. How much the homeowner gets depends on the borrower’s age, the home value and current interest rates, but the payout is reduced by high loan fees charged at closing. Age makes a big difference in how much can be borrowed: someone 62 with $250,000 in home equity can borrow $110,000, but someone 76 can qualify for $150,000. The older they are, the more they can borrow.
California is one of the top ten reverse mortgage markets in the country. But for many folks, reverse mortgages are not a good idea. I saw a really egregious example recently when met with a new client who imprudently signed up for a $250,000 reverse mortgage line of credit several years ago. She borrowed only $6,000 from the line to do a few minor home improvements, then changed her mind and never drew out the rest of the money. Four years later she sold the home and the reverse mortgage came due. She was shocked to find she owed $32,750 for the $6,000 she had withdrawn, including onerous upfront fees plus monthly fees for mortgage insurance and servicing.
There are other drawbacks to reverse mortgages. The entire loan comes due and must be repaid after a nursing home stay of a year or more. A loan in the name of only one spouse will come due when that spouse dies, even though he leaves a widow behind, and the surviving spouse will lose her home.
To be fair, reverse mortgages have a few redeeming qualities – the homeowners can live in the home the rest of their lives, not make any payments, and if there is any remaining equity when the house is sold, those funds go to the homeowners or their heirs. For many, home equity is a resource waiting to be tapped, but I believe that a reverse mortgage, as the product is currently structured, should be a last resort. If refinancing is possible, that should always be considered first. The payments can be stretched over years, the lower origination costs are only on the amount borrowed, and the mortgage interest can be deducted each year.