If you run into financial issues as you age, you may be tempted to take out a reverse mortgage. After all, reverse mortgage companies make it look as if you're borrowing from yourself. Here, we'll lay out the good, bad, and ugly features of a reverse mortgage, as well as possible reverse mortgage scams you want to avoid falling prey to, so you can decide if borrowing from the equity in your home is right for you.
What is a reverse mortgage?
When you purchase a home, you typically make monthly payments to a mortgage company. A reverse mortgage turns that arrangement on its head. Rather than pay a lender to stay in your home, you receive payments each month from the equity in your home. The most common reverse mortgage is called a Home Equity Conversion Mortgage (HECM).
Not everyone is qualified to take out a reverse mortgage loan. Borrowers must meet the following criteria:
- Be at least 62 years of age.
- Spend the majority of the year in the home.
- Own the home outright or have a low balance on the mortgage (although you can use proceeds from the loan to pay off the remainder of the mortgage).
- Not be delinquent on any federal debt, including federal income taxes (again, you can use funds from the reverse mortgage to pay off federal debt).
- Agree to pay ongoing property taxes, insurance, and home repair costs.
- The property must be in good shape. If it's not, the reverse mortgage lender will let you know what repairs must be completed before you qualify for a reverse mortgage.
- Receive counseling from a HUD-approved reverse mortgage counseling agency.
The money you receive from a reverse mortgage is not interest-free. Rather than pay interest to a mortgage company, interest and fees are added to the rising loan balance each month. The money you receive through a reverse mortgage, plus interest and fees, must eventually be paid back. It's normally repaid when you sell the property, or after you die and your heirs sell the property.
How do reverse mortgages work?
One downside of reverse mortgages is that they can be confusing. In essence, a reverse mortgage is an advance on the equity in your home. It's only when you (or your beneficiaries) sell the home that the lender is repaid. While you can make payments on a reverse mortgage if you want to, most people do not. Instead, they receive monthly payments, a lump sum, or sporadic withdrawals of equity. Each payment lowers the amount of equity left in your home.
Although you don't have to make any payments to the lender, you are responsible for paying the property taxes, HOA fees, maintenance, and upkeep of the home. Failure to do so gives the lender the legal right to foreclose on the property or call your loan in as due.
Is a reverse mortgage a rip-off?
Whether a reverse mortgage is a rip-off is a tricky question. That's because there are plenty of ways a reverse mortgage can help a homeowner. For example, some reverse mortgages do not have income or credit requirements, making it easier for a homeowner to access the equity in their property. The funds received from a reverse mortgage are not taxable. And homeowners who are not concerned about leaving their property to heirs don't have to worry about how the home is handled following their death.
However, the dark side of reverse mortgages must also be considered. Possible problems include:
- The number of additional fees added to the loan balance. These include interest, origination fees, and mortgage insurance.
- The interest rate on most reverse mortgages is variable, meaning it can increase, eating away equity at a faster pace.
- Interest paid on a reverse mortgage is not tax-deductible.
- Some reverse mortgage lenders prey on homeowners who need cash to cover their bills.
What is a reverse mortgage scam?
Like any con job, a reverse mortgage scam begins by gaining the trust of a homeowner. Scammers have a special ability to zero in on what desperate people need. They lie about what a reverse mortgage can do for the homeowner, and fail to fully explain how much it will cost. Some reverse mortgage scams work by scaring elderly homeowners into making expensive repairs they don't need.
Given the number of homeowners who have lost their property to this type of scam, it's safe to say that scammers prefer to work with homeowners who don't ask too many questions. For that reason, they often target people who don't speak English well or older homeowners they can confuse.
How do reverse mortgage scams work?
No two scams are precisely alike. Scammers tailor their con to fit the needs of a specific homeowner. However, here are several of the most common reverse mortgage scams:
Equity theft
It takes an entire team to make an equity theft scam work. An equity theft scam takes place when a dishonest appraiser, attorney, and loan officer work together to inflate the value of a home, making the homeowner believe there is more equity in their home than there is. The scammers excitedly encourage the homeowner to "take advantage" of all that equity by taking out a reverse mortgage. "Don't worry," they say. "We'll take care of everything for you."
Once the homeowner has signed reverse mortgage papers, the crooked appraiser, lawyer, and loan officer handle the documents. Once the loan closes, they take the proceeds, leaving the homeowner with nothing.
House flipping
In this scam, the con artists convince an older homeowner that the best way to use the equity in their home is to take out a reverse mortgage and use the proceeds to buy a fixer-upper. The scammer promises to "flip" the house so the homeowner can use it as rental property. The scammer then buys the cheapest house they can find, makes just enough repairs to make the homeowner believe that they're carrying through with their promise, and then takes off with the rest of the money. By the time the homeowner realizes what has happened, they've lost all the equity in their primary property and have a "rental home" that is in total disrepair.
Fraud by someone the homeowner knows and trusts
This may be one of the saddest reverse mortgage scams because it involves someone the homeowner trusts. This type of scam happens when a financial advisor or relative talks a homeowner into taking out a reverse mortgage. They promise to manage the money so the homeowner doesn't have to worry about anything. They may even convince the homeowner to give them financial power of attorney, sweet-talking them the entire way to the attorney's office. The day the loan closes, the friend or trusted advisor tucks the money into their own bank account, leaving the homeowner to fend for themselves.
How do you recognize a reverse mortgage scam?
It pays to be suspicious of anyone who seems too interested in the equity in your home. Here are some of the red flags associated with reverse mortgage scams:
- You have trouble understanding how the reverse mortgage works.
- It feels as though the person explaining the reverse mortgage is being deliberately confusing.
- The offer being made seems too good to be true.
- The person making the offer wants to manage your loan proceeds.
- You're being contacted by people you don't know. It may be via emails, phone calls, or unsolicited advertisements.
- You're told there's "no need" to check with an attorney or financial advisor before signing papers.
- Someone offers to tell you about a reverse mortgage but charges a fee for doing so.
Is a reverse mortgage safe?
Let's say you break a hip and need to recover in a care facility. If you don't have the money to pay for it and don't want to empty your bank accounts so Medicare will take over, a reverse mortgage might be a good way to pay that expense using the equity in your home.
This is important to remember, though: You are free to only take as much as you need to pay that medical expense and to repay it when you can. There's no reason to use all the equity in your house if you don't have to.
So yes, a reverse mortgage can be safe. Your best move is to speak with someone you trust first, whether that's a grown child, your attorney, or your financial advisor. Never allow a salesperson to talk you into a reverse mortgage that you do not fully understand.
Finally, if you do take out a reverse mortgage, make it a HECM. HECMs are insured by the government and provided through FHA-approved lenders. These lenders have additional guidelines in place meant to protect you as a borrower.
