Reverse mortgages are often marketed as a great financial tool for retirees who need extra cash to cover living expenses or medical bills. On the surface, they may sound appealing. You can borrow against the value of your home without having to sell it or move out, and you don’t have to make monthly loan payments. Sounds good, right? Well, as with any financial product, reverse mortgages come with their own set of downsides that are important to understand before making a decision. This article will walk you through the potential negatives of reverse mortgages, so you can weigh the pros and cons carefully.

1. High Fees and Costs

One of the biggest drawbacks of reverse mortgages is the cost. These loans come with high upfront fees, including origination fees, closing costs, and mortgage insurance premiums. For instance, the initial mortgage insurance premium can be as high as 2% of the appraised home value, and the ongoing insurance charge is an additional annual cost. When you add these fees together, they can significantly reduce the amount you actually receive from the loan.

While closing costs are a one-time payment, they can eat into your home equity quickly. If you only need a small loan amount or plan to keep the reverse mortgage for a short period of time, the high fees might make this option less economical.

2. Reduction in Future Home Equity

A reverse mortgage essentially converts your home equity into cash that you can use while you’re still living in the home. But here’s the catch: the more money you borrow, the less equity you’ll have left in your home. This means you could lose an important financial resource that might otherwise help you or your heirs in the future.

Because the loan balance grows over time (thanks to accrued interest and ongoing fees), your equity can shrink faster than you expect. For example, if home prices suddenly decline, you may be left with little to no equity in your home. If you were to sell the property, you likely wouldn’t see much of a profit after the reverse mortgage lender takes their share.

3. Impact on Your Heirs and Estate

Reverse mortgages can also complicate what happens to your home when you pass away. Since the loan must be repaid when the borrower dies or moves out permanently, your heirs may inherit your home with a lien attached to it. This essentially means they’ll have to repay the reverse mortgage debt before they can fully claim the property.

Your heirs typically have a few options for dealing with the debt:

  • Pay off the loan balance (usually by selling the home).
  • Use their own funds or savings to settle the debt.
  • Surrender the home to the lender if they don’t wish to take on the financial burden.

For families who hoped to keep the home within the family, this repayment obligation can be a major hurdle. Additionally, since reverse mortgages reduce the available home equity, there may be little left over to pass on.

4. Eligibility Requirements and Restrictions

Not everyone can qualify for a reverse mortgage. There are eligibility requirements that may limit your options or place restrictions on how you use the loan proceeds. For instance:

  • You must be at least 62 years old to apply.
  • Your home must be your primary residence.
  • You are required to stay current on property taxes, homeowners insurance, and maintenance expenses to keep the loan in good standing.

Failure to meet these ongoing obligations could trigger a default, which might lead to foreclosure. Imagine the stress of potentially losing your home during retirement! This can be especially problematic for borrowers on tight budgets who struggle with rising taxes or unexpected home repairs.

5. Reduction in Government Benefits

Although funds from a reverse mortgage aren’t considered taxable income, they can still impact your eligibility for certain government assistance programs. For example, if you receive Medicaid or Supplemental Security Income (SSI), the cash you take from a reverse mortgage could push your income or asset levels over the qualifying threshold.

It’s important to consult with a financial planner or benefits advisor before moving forward to ensure these additional funds won’t disrupt your eligibility for vital programs.

6. Risk of Outliving Your Equity

A common misconception about reverse mortgages is that the loan will last for as long as you live in the home. While this is often true, it doesn’t account for scenarios where homeowners use the funds too quickly and run out of equity before their financial needs are fully met.

If you take a lump sum payment upfront rather than monthly disbursements, there’s a risk you could exhaust those funds early on. Once your equity is gone, you won’t be able to borrow additional money. Retirees who live longer than expected may find themselves strapped for cash later in life.

7. Market-Dependent Risks

Home values fluctuate, and while they’ve risen steadily in many areas over the years, there are no guarantees. If your home’s value decreases, the amount of equity available to borrow shrinks as well. If this happens before you’ve tapped into your loan, you might not be able to access as much money as you anticipated.

Fortunately, reverse mortgage borrowers are protected by a non-recourse clause. This means you or your heirs won’t owe more than the home’s value, even if the loan balance ends up exceeding it. However, this still doesn’t protect you from losing access to equity due to declining home values.

8. Lack of Flexibility If Circumstances Change

Life is unpredictable, and reverse mortgages don’t always offer the flexibility you need if circumstances change. For instance, if your health deteriorates and you need to move to a nursing home or assisted living facility, the loan typically becomes due within 12 months of no longer living in the home as your primary residence.

You may end up in a situation where you have to sell your home under pressure to repay the loan balance, potentially leaving little or no leftover equity.

9. Limited Loan Options

Not all homeowners can access reverse mortgages. If your home isn’t paid off or has significant existing debt, the amount you qualify for through a reverse loan could be too small to make it worthwhile. Additionally, properties such as co-ops or vacation homes don’t qualify.

For homeowners who don’t fit these criteria, alternative financing options may be more practical.

While reverse mortgages can be a helpful financial tool for certain retirees, they undeniably come with their share of downsides. Between high upfront costs, the potential loss of equity, and the impact on heirs, it’s important to think carefully before committing to this kind of loan.

Take the time to fully understand the terms, fees, and repayment process, and consider whether alternative options like downsizing, refinancing, or selling your home outright might better meet your needs. Speaking with a financial advisor or housing counselor can also help you make an informed decision.