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Reverse mortgages: 7 common misconceptions debunked

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If you're someone who follows personal finance columns, you may have noticed that reverse mortgage loans are starting to shed their once unsavory reputation and are now often regarded as a smart financial tool for older Americans entering into retirement. With safeguards implemented to the FHA-backed Home Equity Conversion Mortgage (HECM), the most common reverse mortgage loan, financial experts and retirement advisers alike are starting to see the advantages offered by this unique loan.

Accessible to homeowners age 62 and older, a HECM reverse mortgage loan allows older Americans to tap into a portion of their equity to help supplement retirement income. With a reverse mortgage loan, homeowners aren't required to make monthly mortgage payments but need to continue paying for property taxes, homeowners insurance, home maintenance costs and otherwise comply with the terms of the loan. Just like a conventional home mortgage loan, if the homeowner defaults on the loan or doesn't comply with the terms, the borrower may face foreclosure -- but this isn't unique to the reverse mortgage transaction.

For those not aware of recent policy changes, a reverse mortgage loan may be perceived as a complicated or risky loan and prospective borrowers may have questions about the efficacy of the loan. To address these concerns, we've highlighted seven of the most common misconceptions asked of lenders today.


#1 'Reverse mortgage loans are a scam'

Actually, today's reverse mortgage loans are quite viable instruments and the FHA-insured Home Equity Conversion Mortgage (HECM) loans are safer than ever. These loans are unique because payment of the balance is deferred until the last eligible borrower or non-borrowing spouse leaves the home and often the sale of the house is used to pay the loan balance (see more about the loan's non-recourse feature under #5).

A reverse mortgage loan is highly regulated, just like most financial products. To qualify:

  • All borrowers must be 62 years or older.
  • The home must be the borrower's primary residence.
  • The borrower must have enough equity in the home to qualify.
  • The borrower must undergo a financial assessment to ensure capability and willingness to continue paying for property taxes, homeowners insurance and home maintenance.

#2 'A reverse mortgage loan is a loan of last resort'

Reverse mortgage loans used to be thought of as a last-ditch effort to get cash while retired. The truth is, while many financial products are created for a single purpose, reverse mortgage loans are not "one size fits all." In fact, homeowners have the flexibility to use a reverse mortgage loan in several different ways. Here are a few:

  • Lump Sum: One single payment to the borrower to be repaid when the loan is due
  • Monthly Installments: Regular payments in the amount you need for a set period of time
  • Line of Credit: Access the available "standby" funds when you need them

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#3 'My spouse or I can be thrown out of the house when one of us dies'

With a HECM reverse mortgage loan, borrowers still retain ownership of the home as long as they continue to pay for home maintenance, property taxes and homeowners insurance, and meet the terms of the loan. As with any loan, including traditional mortgages, if the borrower does not comply with loan terms, such as paying for property taxes, then the property can be subject to foreclosure.

HECM reverse mortgage loans have safeguards that can help ensure that the borrower will be able to fulfill the loan terms for the life of the loan. These include:

  • Eligible non-borrowing spouses are allowed to remain in the home after the borrower of a HECM reverse mortgage loan passes away, as long as the spouse also meets the conditions of the loan.
  • The loan is a non-recourse loan, meaning the lender cannot collect more than the value of the home and the home is the only asset that can be used as collateral.
  • Prior to submitting an application, prospective borrowers are required to undergo independent third-party reverse mortgage counseling to ensure they understand the fine print, what they can expect throughout the loan process, what their responsibilities are and what other options might be available.
  • FHA establishes caps on the amount of money that can be drawn during the first year of the loan to help ensure that proceeds last as long as a borrower needs them.

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#4 'Reverse mortgage loans come with expensive fees and interest'

As with any conventional home mortgage loan, there are fees -- often called closing costs -- that vary depending on the value of the home, loan terms, market conditions and interest rates.

Interest rates and fees are calculated based on a number of factors. Among them include:

  • The borrower's age
  • The home's value
  • The property's ZIP code
  • Any existing mortgage balance or liens
  • Number of expected years in the house
  • Life expectancy

Using this information, a reverse mortgage professional can help determine what the exact interest rates and associated fees are and will disclose your interest rate and fees before the loan is finalized.


#5 'Your home has to be free and clear to qualify'

According to FHA, to be eligible for a HECM reverse mortgage loan, you either need to own your home outright or hold enough equity to pay off the balance with a reverse mortgage. The balance you are allowed to have may vary depending on the home's value, borrower's age, and the loan's interest rate, among other factors.

One of the most important advantages of a reverse mortgage loan is the ability to pay off the existing mortgage and eliminate monthly mortgage payments. Paying off existing mortgages is also required as part of the reverse mortgage loan process. This may help free up cash that would otherwise go toward a monthly mortgage payment, depending on the borrower's specific situation.


#6 'The heirs will be responsible for paying back the loan'

When the last surviving borrower or non-borrowing spouse dies, an heir or the executor of the estate has the option to sell the property and use the proceeds to repay the loan. In this case, the remaining proceeds from the sale can be split among the heirs. The heirs also have the option to repay or refinance the loan and keep the home in the family.

An important feature of the loan is that because a reverse mortgage is a non-recourse loan, the home is the only collateral that the lender may access to pay off the loan balance. This means if the sale of the home does not cover the entire loan balance, then the FHA pays the difference, not the borrower's family.


#7: 'The bank owns your home'

With a reverse mortgage, the borrower retains ownership and the loan is secured by a lien on the home. The borrower does not relinquish ownership using a reverse mortgage loan, but rather, borrows against the value of the home's equity. Just like with any other mortgage loan, as long as you maintain the home, pay property taxes and insurance and otherwise obey the loan's terms, you continue to own your property.

Whether you're nearing retirement with goals of supplementing income or you're just looking for a safety net in times of financial uncertainty, a reverse mortgage loan may help provide greater financial stability in your retirement.

As with any major financial decision, be sure the lender you work with is reputable and trustworthy. Most lenders also encourage prospective borrowers to discuss the decision to take out a reverse mortgage loan with trusted friends, family, a financial adviser and/or an estate attorney. Do your homework! For additional online resources on reverse mortgage loans, go to:

FIND OUT MORE: Learn what a reverse mortgage loan from AAG could do for you.

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