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For reverse mortgage loans: The borrower must meet all loan obligations, including living in the property as the principal residence and paying property charges, including property taxes, fees, hazard insurance. The borrower must maintain the home. If the homeowner does not meet these loan obligations, then the loan will need to be repaid.
What Is the Potential Downside of a Reverse Mortgage?
For many older homeowners, a reverse mortgage may be an option to turn a portion of home equity into cash and improve monthly cash flow. It could offer financial peace of mind, but like any major financial decision, it’s not one to take lightly.
Understanding both the potential advantages and the drawbacks is key to making the right choice for your future. Here are some potential downsides to consider before you decide if a reverse mortgage is the right fit.
Heirs May Not Be Able to Keep the House
A reverse mortgage is considered a non-recourse loan. This means that when the home is eventually sold to repay the balance, neither you nor your heirs will ever owe more than the home’s fair market value. While heirs do have the option to repay the loan with a new mortgage or other funds, most families choose to sell the property to settle the debt.
In practice, this could mean your heirs may not be able to keep the home. However, they will receive money left over from the sale, if any, after the loan is repaid.
Whether heirs wish to keep the home or not, they should contact the loan servicer as soon as possible to review available options and avoid potential issues or delays.
You May Pay Higher Interest and Fees
With a traditional mortgage, borrowers pay down both interest and principal each month. A reverse mortgage works differently. Interest is added to the balance over time and is not paid until the loan becomes due. Because interest continues to build over the life of the loan, the total amount owed is often higher than what was originally borrowed.
Interest rates on reverse mortgages may also be higher than those on conventional mortgages, and since the loan does not have a set term, it is impossible to know upfront exactly how much interest will accumulate. The final cost can only be determined when repayment is due.
In addition to interest, reverse mortgages come with various fees. These may include origination fees, required counseling fees, mortgage insurance premiums, appraisal fees, title fees, surveys, inspections, recording costs, mortgage taxes, credit checks, and other administrative expenses. At a minimum, the borrower will have to pay for the appraisal fee and the counseling fee out of pocket, unless other circumstances apply. Other costs and fees are typically covered through the loan proceeds.
You Hold Less Equity in Your Home
With a traditional mortgage, homeowners build equity by steadily paying down the loan principal. Over time, this increases the share of the home they truly own.
A reverse mortgage works differently. Instead of building equity, you are using some of it in exchange for access to funds. As interest and fees are added and compound over time, the loan balance increases. This means your equity in the home may decrease as time goes on.
It is important to remember that equity is also affected by the home’s market value. If property values rise, that growth may help offset the reduction in equity caused by the reverse mortgage balance. If values fall, equity may decrease more quickly.
You Will Still Have Housing-Related Expenses
While a reverse mortgage may provide financial flexibility, it does not remove all the expenses that come with owning a home. Borrowers are still responsible for keeping the property in good condition, which may include repairs required as part of the lender’s approval process. If the home is not properly maintained, the loan may become due, meaning it must be repaid.
Borrowers must also continue paying property taxes, homeowners and hazard insurance, and any homeowners association fees. Failing to keep up with these obligations can cause the lender to call the loan due in full.
There is No Tax Deduction
With a traditional mortgage, the Internal Revenue Service (IRS) generally allows homeowners to deduct the mortgage interest they pay each year. Reverse mortgages work differently. Interest cannot be deducted annually, and in most cases, it can only be deducted when the loan is repaid in full. Because tax situations vary, it is always best to consult a qualified tax professional for guidance specific to your circumstances.
The Bottom Line
A reverse mortgage may open the door to greater financial flexibility in retirement, but it is not the right fit for everyone. While it can free up cash flow, it also comes with costs, obligations, and trade-offs that should be carefully considered. Weighing both the advantages and the downsides, and seeking advice from a qualified financial professional, can help you decide if a reverse mortgage makes sense in your financial plan.
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This article is intended for general informational and educational purposes only and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.
