Reverse Mortgage: Pros and Cons
In the previous article, we discussed the mechanics of reverse mortgage. We understood how this mortgage is different from a traditional mortgage. We also understood how it works and why it is exclusively used by senior citizens. This article will be less of a description and more of a critical analysis. Every financial product has its pros and cons and reverse mortgage is no different. Incorrect selling often happens in the financial world. Products are sold to people without explaining the pros and cons.
In this article, we will list down the pros and cons of reverse mortgage.
There are obvious benefits to having a reverse mortgage. That is the reason why so many people avail of this product in the first place. Some of the important positive points are as follows.
- No Payments: The most obvious benefit of having a reverse mortgage is that senior citizens do not have to make any mortgage payments. The reverse mortgage loan takes the equity out of the home and makes a lump sum payment to halt the monthly payments. Senior citizens have plenty of bills to take care of and resent making monthly payments. This is the number one reason why people opt for a reverse mortgage loan.
- Lenders Cannot Cut Off Credit Line: The best feature of a reverse mortgage is that lenders cannot cut off the credit line even if the value of the property continues to fall. The line of credit has to increase at a predetermined rate. This is decided by law and cannot be altered by the banks. As a result, reverse mortgage works out to be a line of credit that grows in a predictable manner. Predictability is important to borrowers in their old age and hence makes reverse mortgage loans particularly useful.
- Supplements Old Age Income: Many people spend their lives working hard and want to really enjoy their old age. A lot of these plans involve travel and other activities which cost money. Old people may not have the income required to do these activities. However, liquidating the equity in their homes allows them to fulfill such dreams before they die. The flexibility provided by a reverse mortgage is also incredible. Borrowers can choose whether they want the payment in one lump sum, in monthly payments or as a line of credit.
Reverse mortgages also have a lot of negative points associated with them. They will never be mentioned in any sales pitch or advertisement. However, it is critical that a prospective borrower be aware of them.
- Inheritance with a Lien: Reverse mortgage creates a lien on the property that is used to secure the loan. This lien is up to the amount of money that was borrowed by the borrower plus the interest due. The borrower’s heirs do not inherit the property directly. The bank has a first claim on the property. The heirs are given 6 months to clear the banks due. If they are unable to do so, the bank forecloses the property and pays the balance, if any, to the heirs of the borrower. This loan usually ends with the sale of the property. Hence, people who want their children to preserve the home that they stay in need to stay away from such loans.
- Balance Grows over Time: The balance of a reverse mortgage definitely grows over time. This is because since no repayments are being made, any sum that was borrowed long ago is just sitting there and collecting interest. The problem is that the values tend to compound pretty fast. If the borrower does survive for 10 years or so, then the interest eats up a large amount of equity in the house. Also, if the borrower survives, they have aged significantly and may need more money for medical bills. However, the money has already been exhausted in interest payments! In this scenario, reverse mortgage turns out to be a bad decision.
- Impulsive Spending: People tend to spend more money on impulsive purchases, if they believe that they have a lot of money. The same is true of reverse mortgage loans that are paid out in lump sums or as lines of credit. Senior citizens have noticed that they end up spending a lot more than they anticipated and most of it has been spent towards making impulsive purchases. The fact that interest gets accrued on these purchases makes it all the more dangerous since the monetary loss caused a wrong purchase compounds in value.
- Forced Foreclosure: A lot of times reverse mortgage loans end up in forced foreclosures. Mortgage companies advertise that no payments need to be made to keep a reverse mortgage loan intact. However, that is false advertising and misinformation. The borrower must pay their taxes as well as insurance premium for the loan to be open. In case, the borrower does not make any such payments or undertakes hazardous activities from the said premises, the bank has the option of forcefully foreclosing a reverse mortgage loan. The foreclosure process will involve selling the house to recover the dues and then paying the balance to the heirs.
Authorship/Referencing - About the Author(s)
The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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