Finances - Should Seniors Use Reverse Mortgages?

Some of the most popular products being pitched to seniors today are reverse mortgages. Everywhere you turn there are free seminars, free reports and free DVDs, all touting the amazing benefits these loans offer. Are reverse mortgages the answer to seniors prayers, or are they too good to be true?

It all sounds so wonderful: easy access to your home's equity, no monthly payments, and all without having to sell your house or move. You can have a guaranteed income for the rest of your life! I feel that the sales pitches for these products do a disservice to seniors and, in some cases, can do irreparable damage.

All of us are familiar with a traditional mortgage. You borrow money from the bank using the home for collateral. You are then charged interest on that loan and have to make monthly payments. The larger your mortgage is compared to the value of your home, the less equity (or wealth) has been accumulated.

A reverse mortgage is just like it sounds. You are still borrowing money from the bank and using your home as collateral. The only difference is that you don't have to make monthly payments on what you borrowed. Instead, the interest just builds up. So every month you go further and further into debt and have less wealth.

You don't have to pay off the loan unless you sell the home or no longer live there. Another advantage of a reverse mortgage is that you don't have to have any income to qualify and there are no restrictions on how you use your proceeds.

While these mortgages can be helpful to seniors truly struggling to cover the basics, many seniors see reverse mortgages as free money that can allow them boost their standard of living. Some providers are promoting reverse mortgages as an easy way to pay for that dream vacation or expensive new car. For those with considerable home equity, such possibilities are indeed tempting.

A reverse mortgage is probably the most expensive loan available today. The up-front fees can be astronomical. Here's a real life example. A friend of mine asked me to check out a reverse mortgage being pitched to his elderly parents. The proposal given to them by the bank showed that in order to access $33,000 in equity, they would be charged almost $18,000 in fees! That's over 50%.

His parents had a home worth $230,000 and a $100,000 mortgage. They needed $33,000 and didn't qualify for any other loan. A reverse mortgage has to be the primary loan on the home so enough had to be borrowed to pay off the existing mortgage. So they were paying fees on a loan of $133,000 instead of just the $33,000 they needed.

The lender has to know that they will be able to sell the house for more than you owe on it. That's why they will only lend around 65% of the home's value depending on your age. In some situations, if the home value doesn't appreciate significantly over the years, you could see your equity dwindle away to nothing. You have the miracle of compounded interest working against you month after month.

His parents weren't concerned about the fees because they didn't see it as costing them anything. But it does. That money took decades of making monthly payments to accumulate. It looks just like some numbers on paper, but it can have a very real impact on their future.

The money spent in fees is money that they won't be able to spend on food, medicine or personal care. It's money they won't be able to use to fix the roof or get a new water heater. And if they don't maintain the home, the lender can step in and take it away.

For those who receive a set monthly payment from their reverse mortgage, it's true that they won't run out of money. That doesn't mean there isn't any risk. The monthly payment doesn't increase from year to year, but the price of everything else does. What will you do if that set payment is no longer enough to meet your expenses, and you've lost much of your home's equity to high fees and interest costs?

A reverse mortgage may be right in special situations, but it's anything but free money.