MoneySmart

The Pitfalls of Reverse Mortgages

Is it wise to borrow against your home equity?

A reverse mortgage is a type of loan that allows homeowners to borrow against the equity in their homes while still living in them. Instead of making monthly payments to a lender, the lender pays the borrower in a lump sum, in monthly payments, or as a line of credit. This type of loan may sound like a good idea for older adults who want to supplement their income, but there are several reasons why reverse mortgages are not always a good option, and why people need to be careful.

One of the main reasons why reverse mortgages are not a good option is that they can be very expensive. The fees and closing costs associated with a reverse mortgage can be much higher than those associated with a traditional mortgage. In addition, the interest rates on reverse mortgages are often higher than those on traditional mortgages, which means that borrowers end up paying more over time. This can be a significant burden for older adults who are already on a fixed income and may not have the means to pay for unexpected expenses.

Another reason why people need to be careful is that a reverse mortgage can be complex and difficult to understand. Many people who take out a reverse mortgage do not fully understand the terms and conditions of the loan, which can lead to confusion and financial hardship down the road. For example, borrowers may not realize that they are responsible for paying property taxes and homeowners insurance even after they have taken out the loan. This can be a significant burden for older adults who may not have the means to pay for these expenses on their own.

In addition to being expensive and complex, reverse mortgages can also be risky. If a borrower outlives the loan, they may be forced to sell their home or repay the loan with interest. This can be a significant burden for older adults who may not have the means to repay the loan. Furthermore, if the value of the home decreases over time, borrowers may end up owing more on the loan than the home is worth. This can leave borrowers in a difficult financial situation, and can even lead to foreclosure.

It is also important to note that reverse mortgages are not the only option for older adults who want to supplement their income. There are other ways to tap into the equity in a home, such as selling the home or taking out a home equity loan or line of credit. These options may be more cost-effective and less risky than a reverse mortgage, depending on individual circumstances.

Preparing for retirement is an essential step toward financial security and independence in one’s golden years. Here are some suggestions for saving for retirement, and a few alternative income strategies that can help individuals avoid the need for a reverse mortgage to supplement their retirement income:

1. Start saving early.
It is never too early to start saving for retirement. The earlier one starts, the more time investments will have to grow. Consider setting up a retirement savings plan such as a 401(k) or IRA and contribute to it regularly.

2. Live within your means.
Living below your means can free up money that can be saved for retirement. Budgeting, avoiding debt, and living frugally can help individuals save more money over time.

3. Work with a financial-planning professional and invest wisely.
Investing in stocks, bonds, and mutual funds can help grow wealth over time. However, it is important to invest wisely and seek professional advice.

4. Consider alternative income strategies.
There are several alternative income strategies that individuals can consider as they are saving for retirement. Some options include rental income from a property, dividend income from stocks, or starting a side business.

5. Maximize Social Security income.
For example, delaying Social Security benefits until age 70 can increase the amount of retirement income an individual receives each month.  Also, if you are married, you and your spouse can strategize to maximize your total benefits.

6. Downsize or relocate.
Downsizing to a smaller home or relocating to a less expensive area can reduce living expenses and free up money for retirement savings.

7. Work a part-time job.
Working part-time in retirement can provide additional income while also keeping individuals active and engaged in their community.

These suggestions for proactively saving for retirement can help reduce the need for a reverse mortgage to supplement your retirement income later in life. It is important to plan, seek professional advice from a qualified financial professional, and stay informed about the best options for retirement savings and income strategies.

While reverse mortgages may seem like a good option for older adults who want to supplement their income, they are not always the best choice. They can be very expensive, complex, and risky, and can leave borrowers in a difficult financial situation if they are not careful. Before taking out a reverse mortgage, it is important to carefully consider all the options and to fully understand the terms and conditions of the loan. It may also be helpful to consult with a financial-planning professional, an attorney, and other trusted professionals to determine the best course of action.

For more read: https://www.experian.com/blogs/ask-experian/what-is-the-downside-to-a-reverse-mortgage/

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Grace S. Yung

Grace S. Yung, CFP, is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial LLC in Houston and was recognized as a “Five-Star Wealth Manager” in the September 2017 issue of Texas Monthly.
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