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I recently decided to fact check some of the information that I have heard for years about reverse mortgages. Those in the media with the loudest voices, (Dave Ramsey, Suze Orman) have repeatedly screamed from the rooftops that reverse mortgages are a terrible idea. Today I will look further into reverse mortgages to see if they are as bad as these financial celebrities claim.
As I started to learn about reverse mortgages, all the resources online had one bias or another. Dave Ramsey and Suze Orman were adamantly against them from the start and everyone in favor of them were associated with a reverse mortgage company. I could not find any independent information that spelled out what exactly a reverse mortgage was and the pros and cons associated with them.
For this reason, I decided to tackle the unknowns of reverse mortgages to bring you the most up to date and relevant information so you can make an informed decision. It may be you or a loved one who is considering a reverse mortgage so it’s important to get all the information from an unbiased source.
Before I get into the specifics and the math, let’s first define what exactly a reverse mortgage is and how it works. A reverse mortgage is available to seniors who are age 62 or older and currently live in a paid off, or almost paid off house.
What Is A Reverse Mortgage?
In the most simple terms, if a senior owns their home and is in need of money, they can apply for a reverse mortgage. If approved, a lender will give them a set amount of money in either a lump sum or monthly payments. In return, when the borrower dies or moves out of the home, the lender must be paid back the amount loaned plus fees or the home must be turned over to the lender.
For the purposes of this article, I am going to focus on the Home Equity Conversion Mortgage (HECM) which is backed by the Federal Housing Administration (FHA).
The Basic Steps Of A Reverse Mortgage:
The Senior Applies For A Reverse Mortgage
The application for a reverse mortgage is relatively simple. A simple search on the internet will give you a number of lenders who specialize in reverse mortgages. The application process is relatively similar to that of a traditional mortgage. A credit check will be conducted and if approved, they will offer you terms of a loan.
Reverse mortgages and their terms are based on age. If the primary borrower is married, the terms will be calculated based on the age of the youngest spouse as long as they are age 62 or older. The age determines the amount that will be paid out to the borrower. The younger the borrower, the less money will be offered.
If the home is paid off, the lender will typically offer an amount that is less than 80% of the homes equity. The reason for this is to account for additional fees that will be added to the loan. For instance, if the value of the home is $300,000, the mortgage offered will not usually be more than $240,000.
Reverse Mortgages Have Several Different Payment Options
One incentive is the tax-free status of the money paid to borrowers. The federal government does not tax the money that is given to the borrower. With that being said, three of the most common payment methods are:
- A lump sum payment (only 60% of the total lump sum can be paid in the first year)
- Monthly payments based on a structured term (set number of years)
- Monthly payments for life (tenure)
Once the borrower is approved for the loan and receives payment, the loan (i.e. $240,000) accrues interest throughout the life of the mortgage. The borrower can either make payments back to the loan monthly, yearly or not at all.
Reverse Mortgage Repayment Options
The reverse mortgage must be paid back in the following two situations:
- When the borrower dies
- When the borrower moves out of the home
- *the borrower is not required to pay back any of the loan if they are still alive and living in the home
When the borrower dies, there are three options:
- The heirs must repay the loan if they want to keep the house. They can either pay the loan back or 95% of the home’s value, whichever is less
- The heirs can sell the home and pay back the loan with the proceeds and keep the rest as equity
- The heirs can hand over the keys to the bank and the mortgage will be considered paid in full
- *the bank cannot force the heirs to repay the loan and the bank cannot force any additional estate funds to repay the loan – the home is the only collateral
In certain circumstances, it may not be an option for the borrower to remain in the home. If the borrower becomes very ill and must be in a nursing home or live with family, the loan must be repaid in one of the above-listed manners. As part of the loan terms, the home must be the primary residence of the borrower.
If the borrower no longer lives in the home, there are three options:
- The borrower can repay the loan either by refinancing into a traditional mortgage or by using personal savings or retirement funds
- The borrower can turn over the keys to the home to the lender and the debt will be paid in full
- The borrower can sell the home
- *if the loan balance exceeds the home value, the borrower is only responsible to repay the amount the home sells for
When The Senior Can Be Forced Out Of Their Home
Because a reverse mortgage is not required to be repaid while the borrower is alive and still in the home, there is only one real scenario when the senior can be forced out of their home.
One of the terms of the reverse mortgage is the borrower is required to maintain the other financial responsibility of owning a home. HOA fees, property taxes, insurance, etc. must still be paid by the homeowner. In the event these fees are not paid, liens can be put on the home and eventually the senior can be evicted and the home turned over to the lender.
As long as the homeowner remains current with the financial obligations of owning a home, they can not be forced out of the home if they live for much longer than expected.
The Myths About Reverse Mortgages By Dave Ramsey
These myths are from his article How Reverse Mortgages Work.
Dave Ramsey has a strong opinion about reverse mortgages. He advises against them in all situations. With that being said, he puts forward a few myths and half-truths that are not accurate about reverse mortgages.
Dave Ramsey Reverse Mortgage Myth #1
As stated on his website, during the term of the reverse home mortgage, “You could lose your home.” These words are printed in big bold letters in his article. This statement is incredibly misleading because you will not lose your home simply because you have a reverse mortgage.
You would lose your home in the event you fail to pay your HOA dues, taxes, and other financial responsibilities. The result of not paying these bills would result in you losing your home with or without a reverse mortgage. This is not exclusive to a reverse mortgage.
Dave Ramsey Reverse Mortgage Myth #2
Dave states, “You’ll likely owe more than your home is worth.” This statement is a half-truth intended to scare you from knowing the accurate information. Dave Ramsey justifies this with the following scenario from his article:
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- Home Value :$200,000
- Reverse Mortgage : $80,000 (lump sum)
- Interest Rate: 5.7%
- Age at Time of Loan: 62
- Term: 25 years
- Total Interest Accumulated: $119,000
- Total Owed at Death $319,863
With these numbers, it does look scary and he does a great job at portraying this. Realistically, upon the borrower’s death, the heirs of the estate have two options.
- The heirs can turn over the home to the lender which will settle the entire amount owed, regardless of the home’s value.
- The heirs can purchase the home for 95% of the homes market value, or the total amount of the home – whichever is less.¹
So while on paper the $319,863 is “owed”, this is not the amount any heir would have to pay to settle the debt or to own the home. Some of the fees in the loan account for the FHA insurance that is required. This is insurance paid by the borrower that is to the benefit of the lender. The FHA insurance pays any outstanding difference in the event the home is sold for less than the outstanding debt.
The Numbers And Reality Behind A Reverse Mortgage
Let’s go over the basic math involved in a reverse mortgage and what a borrower can expect to receive. For this scenario, I used a reverse mortgage calculator found here.
For these calculations, I put in a 70-year-old adult who applied for a reverse mortgage loan on a $300,000 house with a lifetime monthly payment (tenure) option.
From this table, you can see the value of the home is $300,000. The limit allowed to be borrowed is $134,099 after fees.
Based on this estimate, the borrower would receive $721.76 a month for the rest of their life. For the loan amount of $134,099, the borrower would need to live for an additional 15 years (to the age of 85) to receive the full $134,099 from the monthly payments.
The total amount owed would depend on how long the borrower lived. If the borrower lived until the age of 85+, they would have accrued approximately $56,000 in interest and their total loan would be $203,900.
Keep in mind that for this scenario, only $147,900 (before fees)was borrowed from the $300,000 home. Some lenders allow up to 80% of the home’s value to be borrowed which would be a loan of $240,000. This would significantly increase the monthly payment but it would also significantly increase the amount of interest owed.
Does A Reverse Mortgage Make Sense Mathematically?
No, absolutely not. However, that alone should not influence your decision about reverse mortgages – let me explain.
Mathematically, you are taking a loan out for a large amount. For the life of the loan, you would be paying over 4% in interest on the total outstanding amount the entire time. This interest would continue to rack up until the loan is paid back, the home is sold, or the home is turned over to the bank.
For instance, an interest rate of 4.5% would be charged against the amount and would compound as more interest was added to the outstanding balance. The balance increases during the life of the loan and the interest rate is charged against the loan as it continues to grow.
If you were to take out a traditional mortgage for a home, the amount you pay in interest would decrease during the life of the loan because you are paying down the debt. The smaller the outstanding debt, the less interest you owe.
The Best Mathematical Option
The best option is to sell the home outright and avoid a reverse mortgage. However, doing this will provide the senior with a lump sum that would need to last as long as their life. There is a finite amount of money with this option that could be reduced if the senior purchases another smaller home.
With a tenure (lifetime) reverse mortgage payment option, the senior would be guaranteed a steady income for life. Even if over the course of their life the senior ends up being paid more than the home is worth, they will receive steady payments which will be added on to the total mortgage debt.
Options To Consider Before Getting A Reverse Mortgage
Even with the above information, a reverse mortgage should be an absolute last option. There are other options that make more financial sense and have longer sustainability for seniors in retirement.
Option #1 – Double Check Your Budget And Expenses
If you or a family member are running out of money, the budget or lack of one may be an issue. Make sure you have created a proper budget and delegated your money to your needs first and your wants second. If you find yourself spending more money than you should on wants, it may be time to cut back in these areas.
If you need help creating a budget, I have created a great article to get you started and I also provide free budget printables!
Option #2 – Downsize Your Living Arrangement
If you are living in a $300,000 home and you need a little extra income in retirement, an option may be to sell your home and purchase something smaller. Condominiums and other shared living spaces can be purchased for much less than a large single family home. This may be a great option to add extra cash to the retirement fund to increase the interest payments on the investments.
In contrast, downsizing may not be the best option if your retirement funds are depleted. If your home is worth $300,000 and you downsize to something worth $150,000, that is a lump sum of $150,000 you now have to live off of for the rest of your life. Is this enough or will it run out before your life runs out? Find out how much money you need each month and divide your total retirement by that amount. That will give you a rough estimate of how many months of income you will have, not counting any interest earned.
Option #3 – Move In With Family
Selling the home and moving in with family members is another great option to consider. Often seniors have difficulty with this decision because they do not want to be a burden to their family. While I understand this, I doubt your children or family members want to watch their loved one starve to death because they ran out of money in retirement.
Hard conversations need to be had in these situations. With the sale of the house, you could help support your family members financially to ease any type of added financial burden. Family needs to stick together and if this is something that is possible, it should be considered before a reverse mortgage is an option.
When Does It Make Sense To Get A Reverse Mortgage?
As odd as it sounds to talk about the positive of a mathematically terrible financial decision, I feel there are instances when a reverse mortgage does make sense. I only suggest a reverse mortgage if you are willing to take the tenure (lifetime payment) option, for it to possibly be a good idea.
Here are the instances when I believe a reverse mortgage may make sense. All of these criteria must be met for it to be a realistic option:
- When the borrower’s home is paid off and they do not have enough money in retirement or social security to live a healthy life.
- When the borrower does not have any family or friends that can help them financially.
- If the income from a lifetime monthly reverse mortgage payment is enough to sustain life in retirement to include HOA and property taxes on their home.
- The borrower must expect that their heirs will have to sell the home or give it back to the bank after their death. It can not be relied upon as any part of an inheritance.
- A reverse mortgage should be an absolute last option.
- It never makes sense to take the lump sum or term payments that expire.
A Reverse Mortgage Fact Recap
- A reverse mortgage should only be considered as a last resort.
- The only reverse mortgage option that should be considered is a tenure (lifetime) monthly payment option.
- A reverse mortgage means you plan for your heirs to sell the house or turn it over to the bank after your death.
- Consideration should only be given for a reverse mortgage if the extra money provided is enough to pay all the necessary bills to include home ownership fees (i.e. HOA, property taxes) for life.
- Heirs will not be required to pay any extra money to settle a reverse mortgage debt if the debt amount is more than the value of the home. FHA insurance will cover the difference.
- To keep the home, your heirs must either pay back the full loan amount or 95% of the homes appraisal value at the time of the borrower’s death.
- You can not be evicted from the home if you are current on your financial responsibilities outside of the reverse mortgage.
The Quality Of Life Argument
From the above information, it’s clear that a reverse mortgage is not the best mathematical decision to make. However, to say they should not be used in any situation may be setting seniors up to live off ramen noodles for the rest of their lives. There are certain situations when a reverse mortgage makes sense to improve or sustain a certain quality of life.
Towards the end of life, quality of life is much more important than how many zeros are in your bank account or how much your home is worth. If you are at the end of your rope and have no other options, a reverse mortgage may be the bad financial answer to let you live more comfortably through your last years.
The guaranteed lifetime monthly payment (tenure) gives some security to a bad financial situation.
What are your thoughts on reverse mortgages? As controversial as the topic is, it is important to get honest information from all sources. Comment below if you have had any experience with a reverse mortgage and what your thoughts are on the topic!