Image source: Flickr user Shankar S.
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For those in need of more income in retirement, reverse mortgages can seem like a dream come true. Based on the equity you've built up in your home over many years, a lender starts sending you checks regularly (or in a lump sum or line of credit) -- and you get to stay in your home, too! Reverse mortgages can indeed serve many retirees well, but they're not perfect for everyone, and they have some downsides worth considering.
A reverse mortgage is essentially a loan, with the amount borrowed not having to be repaid until you die, sell your home, or stop living in it (perhaps because you moved to a nursing home). At that time, the home can be sold to cover the debt, or your heirs can pay it off and keep the home. Reverse mortgage income is often tax-free, which is another big plus.
There's money in your house that a reverse mortgage can tap. Image source: Getty Images
Dangers, pitfalls, and things to know
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There are some dangers and pitfalls associated with reverse mortgages, though, and in many cases, what you don't know can cost you. Let's run through some facts.
- For starters, many people have been pressured into reverse mortgages by pushy salespeople. Reverse mortgages can be complicated contracts, too, so be sure to review all the terms closely, to ask questions, and perhaps to have a financial professional review the deal.
- Reverse mortgages feature closing costs, just as with regular mortgages, and they tend to be costlier. The applicable interest rates tend to be higher, as well.
- You may not receive as much income through a reverse mortgage as you might have expected. The amount you can borrow depends on factors such as how much longer you (and your spouse, if you have one) are expected to live, the value of the home, the equity you have in it, and prevailing interest rates. Interest charges are added to the balance of the loan over time.
- You'll still be on the hook for home-related expenses such as property taxes, home insurance, home repairs, and maintenance. Those can be substantial. Miss out on some of these payments, such as property taxes, and your lender might be able to closeout the loan, causing you much grief.
- Once you leave your home, it will likely need to be sold to pay off the reverse mortgage. If you'd hoped to leave it to your children, you won't be able to do so unless the reverse mortgage loan can be paid off in some other way. Some people have run into troubleif they got sick and were out of their home for an extended time, such as in rehab -- as their lender then moved to close out the loan and take possession of the house.
Don't end up surprised by some of the terms in your reverse mortgage. Image source: Getty Images
- Receiving income from a reverse mortgage might hurt your eligibility for various benefits, such as Medicaid and Supplemental Security Income. So while it can boost your income, it may also reduce it. Yikes!
- In the past, when a reverse mortgage holder has died, the surviving spouse often ended up defaulting on the loan and facing foreclosure. Regulations have recently strengthened protections for spouses, but it's worth taking a close look at any fine print and asking pointed questions. It can be especially dangerous if your spouse is not included in the loan.
- When some people have tried to refinance their mortgage, they've discovered that their equity is much smallerthan they thought, because holding a reverse mortgage shrinks your equity in part via accrued interest expenses over time.
- Some people have complained to the Consumer Finance Protection Bureau that their reverse mortgages with variable interest rates raised the rates too quickly, costing them more, and that they were not able to renegotiate terms.
- If you're not disciplined, you can spend too much of your reverse mortgage money too soon (especially if you've received it as a lump sum) and can end up in worse financial shape.
Be smart about reverse mortgages
The key to knowing whether a reverse mortgage is right for you is to learn everything you can about them. In some cases, if you need the income and liquidity that they can provide, then reverse mortgages will be a good tool in your retirement financial plan.
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Longtime Fool specialistSelena Maranjian, whom you can follow on Twitter, owns no shares of any company mentioned in this article.Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.