Comparing the Costs of a Reverse Mortgage
Article by R. Joseph Ritter, Jr. CFP® EA
One of the disadvantages to the reverse mortgage is that the amount you receive is not the full amount of the mortgage. HUD and FHA allow only a certain percentage of your home’s value to be paid to you in a reverse mortgage. HUD maintains a very detailed spreadsheet which lists the percentages available at different ages and based on different interest rates. How much you can borrow depends on your age and interest rates. An individual age 62 can borrow substantially less than an individual at age 80. The lower the rates the more you will receive. The higher rates climb the less you will receive. With interest rates around 4%, borrowing limits are approximately 60% of home equity for traditional reverses mortgages and 50% of home equity for the HECM Saver. Because reverse mortgages use adjustable interest rates, you are not protected against changes in the interest rate. Some adjustment to the interest rate over time is built into the amount you can borrow against your home in a reverse mortgage, however, if interest rates adjust more than predicted, all of the equity in your home can be quickly depleted.
Although HUD has set the amounts you can borrow against your home, you do not receive all of this money in a reverse mortgage. The bank deducts the closing costs that are financed at closing. If your reverse mortgage is for $150,000 and your closing costs are $13,000, then the amount you receive will be $137,000.
To be fully informed as to the costs of a reverse mortgage, you should compare the costs against a traditional mortgage before you make a decision to sign the mortgage documents. If you were to borrow $150,000 against your home that is worth $250,000, what would it cost if you were to do a traditional or reverse mortgage?
Term of Years
Total of amounts to be repaid:
$156.25 X 240 months
$35 X 240 months
3.885% var. HECM 100
$45,900 ($191.25 X 240)
If you needed to tap $150,000 of the equity in your home during your retirement, the above illustration shows that the reverse mortgage is more expensive than the traditional mortgage by almost $100,000. It is certainly true that many senior citizens may not be able to afford the monthly payments on a traditional mortgage, however, if you need to tap the equity in your home, that probably also means you do not have a spare $100,000 sitting around to give to the bank.
It is also unlikely that your $250,000 home would have appreciated enough to cover the entire balance of the reverse mortgage after 20 years, so there would be nothing left of your home to pass to your children, heirs and beneficiaries.
The money to pay back the reverse mortgage does not come directly from your pocket but is being taken from your children, heirs and beneficiaries. Plus, your home will need to be sold to pay off the mortgage when you pass, move into a life care facility, or move to a relative’s home if you are unable to care for yourself anymore.
If you instead used a traditional mortgage, the balance due at your death or when you moved out of the home would be the outstanding principal only, which would be less than when you first took out the mortgage. If your assets are not sufficient at that time to pay the mortgage off, then the home would still need to be sold. However, if your home is worth $250,000 today, it is quite likely that there would still be equity left over in 10, 15 or 20 years from now to pass to your children, heirs and beneficiaries or to use toward your own care if you were moving into a life care facility or a relative’s home.
There are other costs as well that may not be felt directly by you. According to the USA Today, FHA is struggling with $5 billion in losses from reverse mortgages and recently requested a cash infusion from the U.S. Treasury in the amount of $1.7 billion. The reverse mortgage is, therefore, putting a strain on federal taxpayers who are bearing the effect of FHA’s losses. Many of the losses are likely due to the housing bubble and housing crisis when many homes were suddenly inflated in value and just as suddenly decreased in value.
One of the buzz phrases I hear in reverse mortgage advertisements is that it costs less if you keep the reverse mortgage for a long time. This buzz phrase is to be interpreted to mean that, if the closing costs on George’s reverse mortgage are $12,250, this would be an unwise expense if he only planned to keep the reverse mortgage for two years. The question you have to ask yourself is this: If it is expensive if the mortgage is only kept for two years, how is it less expensive if I kept my reverse mortgage for 10 years? The answer is that the costs are not less if you keep the reverse mortgage longer. Instead, the total expenses will be substantially higher.
In the advertisements, they are simply making a play on the closing costs being spread out over two years versus 10 years. It is confusing to understand and misleading because the reverse mortgage does not cost less no matter how long you keep it.
Such advertisements are being made by banks who are conflicted. They stand to make more money in interest and monthly service fees if you keep your reverse mortgage longer, so to say that it costs less if you keep it for a long time is really an attempt to part you with more of your money. Heavy marketing, emotional pitches to seniors, heavy availability and wide acceptance and promotion that accompany reverse mortgages do not mean that the reverse mortgage is a good or even useful product. Banks and others in the financial industry stand to make many millions if not billions of dollars from reverse mortgages at the expense of a senior citizen’s family, heirs and beneficiaries, and at the federal taxpayer’s expense as well.