Reverse Mortgages - The Good, Bad and The Ugly (originally published 5-5-10)

The Department of Housing and Urban Development (HUD) administers FHA insured Home Equity Conversion Mortgages (HECMs), commonly referred to as Reverse Mortgages.  Reverse Mortgages are different from traditional mortgages because they don’t require monthly repayments towards the amount borrowed.  This arrangement provides “cash poor” homeowners with much needed cash.  Sound too good to be true?  Well, maybe yes and maybe, no - let’s look at the good, bad and ugly aspects.

The Good… Homeowners, age 62 and above, who have sufficient equity in their residence may borrow against some of the equity (similar to a Home Equity Loan) and receive cash for the net proceeds of the loan.  There is no requirement to repay the loan while you continue to live on the property.  The proceeds are not considered taxable and do not impact negatively any amounts you would receive for social security or Medicare.  You retain title to the property and if the value of the property were to fall below the outstanding loan amount, the lender cannot foreclose on the property.

The Bad…  The current depressed real estate market has depleted much of the value of residential properties.  The equity once available to the homeowner for securing loans has shrunk.  Most of the banks in our area do not even offer reverse mortgages.  That shouldn’t be a surprise given the recent bank failures due to overextended real estate loans.  Banks want to avoid future risks.  Those institutions that do offer reverse mortgages will charge origination fees, closing fees, appraisal fees and FHA insurance at the closing, reducing further the net proceeds available to the borrower.  Since there are no repayments, the interest on the loan will continue to build and be added to the loan amount.  That interest is also not tax deductible until paid at the end of the loan (when you die, or the house is sold).  

The Ugly… Homeowners who enjoy a long life will most likely outlive the equity in the home -the build-up of interest will eat up all the equity in the property.  That means the bank will get the property when you pass and your heirs get nothing.   If you do go the reverse mortgage route, give your heirs the ugly news when you get the loan.