Exploring Both the Benefits and Negatives of a California Reverse Mortgage
Navigating Reverse Mortgage Pros and Cons: A Deep Dive
presented by John Correll, CRMP
Certified Reverse Mortgage Professional in California
Considering a reverse mortgage can be a big decision. They have been hailed as a means to help attain a secure retirement and enhance the quality of life with less worry about money. For many that has been true. However, it's important to recognize that, like any financial product, reverse mortgages come with both benefits and drawbacks. Explore this guide on the pros and cons of using home equity and more specifically reverse mortgages. You will find an unbiased review of both the positives and negatives of the reverse mortgage.
Our goal here on this page is to better equip you with the knowledge needed to make a well-informed decision for yourself and avoid potential pitfalls as you contemplate this option for your retirement planning. While this guide explores both sides, the best way to truly make an informed decision is to request a quote, ask questions and bring in trusted advisors or maybe family members to help you make the best choice for yourself.
What is a Reverse Mortgage?
A reverse mortgage is a special type of home mortgage for older homeowners, usually those who are 62 or older (as low as age 55 on certain types). It can allow some who qualify turn some of their home's value into cash. Unlike regular mortgages where the borrower makes payments each month to the bank or mortgage company each month, with a reverse mortgage, monthly payments are not required.* The borrower can access loan proceeds as a lump sum, a line of credit, or regular disbursement payments to them. The unique thing about reverse mortgages is that the borrower has no requirement to pay anything monthly, but the loan amount, which includes interest, increases over time. This structure can allow for much lower expenses during retirement while in the home. When they eventually sell the home, move, or pass away, the loan gets paid off, often by selling the house or by refinancing out of the reverse mortgage by the heirs or borrower. While reverse mortgages can offer extra income for retirees, they come with costs and can affect your home's equity.
*Please Note: while a reverse mortgage has no monthly mortgage payment, the borrower(s) must continue to pay their property taxes, homeowners insurance bills as well as other housing costs like maintenance or hoa dues (if any). Also at least one borrower must continue to live in in the home as their primary residence.
The most common type of reverse mortgage is called a home equity conversion mortgage (HECM). These loans are insured by the Federal Housing Administration (FHA). To participate, borrowers pay an insurance premium that goes into the FHA reserves. There are also "proprietary" or "jumbo reverse mortgages" which offer loan amounts up to $4 million.
To qualify for an HECM, here are a few of the qualifying criteria:
- At least one borrower should be at least 62 years old. (proprietary reverse mortgages off min age of 55)
- The home must be the primary residence.
- Borrower must own the home and have substantial equity.
- There will be a credit check and meet other eligibility conditions reviewed by underwriting.
- The borrower must keep up with ongoing property taxes, insurance, and any homeowners association (HOA) fees.
- Borrower will need to attend an information session led by an approved HECM counselor (can be done by phone or in person).
- Other qualifying conditions will apply - this is not a complete list
How Does a Reverse Mortgage Work in California?
Curious about how reverse mortgages function? It might be easier to compare and contrast it with a traditional mortgage to understand better how a reverse mortgage works.
Traditional Mortgage: Traditional mortgages involve receiving a lump sum from the bank or mortgage company at time of closing, either to purchase a home or perhaps as a cash out refinance. Payback occurs over a determined number of years and the borrower makes a payment each month to the lender. The loan is payed back with interest over time until the loan reaches zero.
Its important to note with a traditional mortgage the borrower has the burden and requirement of a monthly mortgage payment or they risk foreclosure.
Reverse Mortgage: In contrast, a reverse mortgage works the opposite way. Here, the lender pays the borrower who has the option to draw money at closing or by offering options like a lump sum, monthly payments, or a line of credit. The initial reverse mortgage loan might also involve a "refinance" of a traditional mortgage into the new reverse mortgage to improve cashflow and lower monthly obligations. The loan's interest and fees on the reverse mortgage are added to the balance each month, causing the debt to grow bigger over time. This can impact home equity which can decrease unless the home's value increases faster. Payback works quite differently - with no monthly mortgage payment required on a reverse mortgage*. During the life of the reverse mortgage, the borrower will maintain ownership of the home throughout, and the debt is only due when there is a maturity event. A maturity event involves the last borrower moving out of the home (or death) or failure of the borrower(s) to keep current on property taxes, homeowner's insurance and other things such as maintenance or hoa dues (if any) After a maturity event, the home can be sold by heirs to settle the debt or payoff via refinance or other assets. Any remaining equity goes to the estate. If the debt exceeds the home's value, the heirs aren't obligated to cover the difference - this is called a non-recourse feature which protects the borrower and estate. They can also choose to pay off the reverse mortgage with their own funds or refinance and payoff the reverse mortgage to retain the property if they wish to keep the property.
*Its important to note with a reverse mortgage the borrower has no monthly mortgage payment requirement like a traditional mortgage which can make the risk of foreclosure much lower, however at least one borrower must continue to live in the home, pay ongoing housing expenses like property taxes, homeowners insurance and maintain the home.
Reviewing the Advantages or Positives of a California Reverse Mortgage
7 Pros of a Reverse Mortgage
To begin, let's look into a few appealing benefits that make reverse mortgages a popular choice for many.
Pro #1. Borrow Funds Without The Burden of a Monthly Mortgage Payment*
Without a doubt, this is probably one of the main reasons reverse mortgages are so popular and what attract many older homeowner's to them. Once in retirement many older homeowners are on a fixed income and often worry about money. The reverse mortgage can solve that probably by offering the ability to tap into a financial loan product that has a very flexible payment schedule and no required monthly payment.* This makes the reverse mortgage unique, dynamic and powerful. The borrower can access funds, consolidate debts and lower monthly payments.
Unlike a traditional mortgage where the borrower must make monthly payments to the lender, the reverse mortgage does not have a monthly payment requirement*. While on the surface many think this sounds too good to be true or there must be a catch. The concept how they work is simple. The bank or mortgage company still charges interest, but the reverse mortgage gives the borrower the option to defer the payment on the interest and allow it to get added to the loan balance. (this is what most people with a reverse do - though the borrower can make payments at any time they choose) So the loan balance will grow larger over time - but the entire loan balance is paid back at the end - most of the time this happens when the borrower or heirs sell the home although the balance can also be paid off or refinanced into a new loan by the borrower or heirs if they wish to keep the home and not sell it.
*Please Note: while a reverse mortgage has no monthly mortgage payment, the borrower(s) must continue to pay their property taxes, homeowners insurance bills as well as other housing costs like maintenance or hoa dues (if any). Also at least one borrower must continue to live in in the home as their primary residence. DISCOVER THE POWER OF NO MONTHLY MORTAGE PAYMENTS FOR YOURSELF.
Pro #2. No Taxes Due On the Funds Drawn Out of the Reverse Mortgage*
According to IRS guidelines and their own website, funds received from a reverse mortgage are categorized as a loan proceeds and not income. This is very important because it means that these funds drawn from a reverse mortgage are untaxed. This information can be found on the IRS website here: LINK TO IRS WEBSITE WHICH COVERS THIS TOPIC ON REVERSE MORTAGE PROCEEDS
Many savvy reverse mortgage borrowers coordinate with their financial advisor on creative ways to maximize the use of their reverse mortgage to accomplish goals including those that involve taxes. (borrower should consult their own advisor to explore these strategies). One strategy is a reverse mortgage can reduce tax obligations during retirement by drawing funds needed out of home equity and their reverse mortgage instead drawing out of taxable investment accounts such as an IRA, 401k or other investments which could have taxable consequences.*
* This is not to be considered tax or financial advise. Borrower should consult their own tax or financial advisor for their own situation.
Pro #3. Stay In Current Home Without Having to Move
The reverse mortgage at its core is designed for older homeowners who desire to stay in their home and age in place. Selling the home can involve expensive real estate commissions, moving expenses and then renting or having to find another home to buy or live in. While there are costs to the reverse mortgage in the long run securing a reverse mortgage and staying in the home they love can often times be the lowest cost solution. Its important to weigh everything, but for those who want to access some of the equity in their home and have improved cashflow, for many the reverse mortgage has worked out incredibly well as a long term solution.
Once a reverse mortgage is setup, if you read the fine print - the borrower can remain living in the home until age 150 or until a maturity event - which essentially means for their lifetime as long as they live in the home and continue to pay the ongoing property taxes, homeowners insurance and maintenance expenses. While nobody has actually lived until age 150, the way reverse mortgages are setup today they can be a viable option for many to remain in their home even up until the day they die and for their lifetime so they can enjoy the home they love with the additional benefits of the reverse mortgage.
Pro #4. Funds Can Be Used Anyway Desired
Funds from a reverse mortgage can be used for anything the borrower desires. As covered in #2 above they are loan proceeds and not taxable income. The borrower has the flexibility to receive their funds in various ways: as a lump sum, through a flexible line of credit, in monthly payments for a specific term or for life, or even a combination of these choices.
Popular uses of reverse mortgage funds include:
- Supplement Retirement Income: To have more money for daily expenses, healthcare, or a better retirement lifestyle.
- Consolidating debts to lower monthly payments: Getting rid of monthly payments on existing loans or mortgages to reduce monthly bills by consolidating those debts into the reverse mortgage
- Home Upgrades: Making improvements to the home for safety or comfort.
- Cover Medical Costs: Paying for healthcare or insurance.
- Enjoyment: Funding vacations, hobbies, or leisure activities.
- Help Family Members: Assisting family members with education or home purchases.
- Emergency Savings: Setting aside money for unexpected expenses.
- Home Repairs: Fixing essential maintenance issues.
Pro #5. Safety of a Line-of-Credit With a Lifetime Draw and Growth Feature
HECM REVERSE: With a HECM reverse mortgage line of credit, the borrower can take comfort in knowing that their available funds not drawn out and held in their line-of-credit remain secure as long as they meet their obligations, thanks to HUD's guarantee. Funds on the HECM line-of-credit can be drawn for the lifetime of the reverse mortgage. This means if the borrower needs funds in 15 years the line-of-credit will be there as long as they continue to live in the home and pay the property charges like taxes & homeowners insurance and maintenance expenses. Do those simple things and the HECM reverse mortgage line-of-credit will stay open and ready until funds are needed.
HELOC Home Equity Loan: This in not the case with most home equity lines of credit (HELOCs), which banks can abruptly freeze or eliminate. HELOCs also come to an end of their "draw period" which is normally only 10 years. After that the HELOC not only does not allow for more draws, but the borrower must then move into a repayment phase where payments can skyrocket as they generally must now pay not only interest but principal. Some people's payment triple once they enter repayment with a HELOC - but not with a reverse mortgage.
DRAW PERIOD ON MOST HELOC Home Equity Loans LINE-of-CREDIT: 10 years then line-of-credit closes
DRAW PERIOD ON HECM REVERSE MORTGAGE LINE-of-CREDIT: Lifetime open draw period
Bonus Features Unique to a HECM Reverse Mortgage Line-of-Credit:
- Lifetime draw on line-of-credit proceeds*
- Growth on available Line-of-Credit Funds - Growth takes places on the amount in the available line-of-credit not drawn out. This provides borrower access to increasing amounts of borrowing funds over time as the size of the available funds gets bigger over time
- Line-of-Credit Cannot be Cancelled Due to a Drop in Home Value - Many banks closed traditional HELOC loans during the 2008 - 2010 housing crash. This was not the case with any HECM reverse mortgage borrowers as the line-of-credit is guaranteed by HUD and the line of credit will remain open even if the home prices drop after closing.
* PLEASE NOTE: For the loan to remain in good standing the the HECM line-of-credit to remain open, at least one borrower must continue to occupy the home as their primary residence, pay ongoing property taxes, homeowners insurance bills plus maintenance expenses on the home.
Pro #6. Protections For Borrower and Heirs if Loan Balances Exceeds Home Value
- Non-Recourse Protection for Heirs and Borrowers - A reverse mortgage is a non-recourse loan. With a non-recourse loan, the borrowers (nor heirs) are not personally liable for repaying the debt, and the lender can only seek repayment from the collateral, typically the property itself. The same protections apply for heirs - so if the house is "under-water" at time of death of borrower and the loan balance on the reverse mortgage is higher than the value of the house - the estate is not liable. However if the value of the home is higher and there is equity - the heirs or estate can sell the home and keep the remaining equity for their inheritance.
- Heirs Have Options Upon Death of Last Borrower - Built into the reverse mortgage program are flexible options for the heirs of a parent, relative or someone who has a reverse mortgage on their home at the time of their death. The reverse mortgage becomes due an payable once the last borrower has died (or another maturity event) In the event of an estate situation, heirs face several choices: They can sell the property, use the proceeds to settle the debt, and any remaining equity above the loan balance will belong to the heirs of the estate as part of their inheritance. Alternatively, they can choose to keep the home and refinance the reverse mortgage balance if the property's value allows for it. It might even be possible for heir to get a reverse mortgage in their own name to payoff their parents reverse mortgage. We have assisted a number of clients with this. In cases where the debt surpasses the property's value, heirs can resolve the loan by returning the title to the lender with no personal liability to the heir or estate. As soon as possible after death, the estate should contact loan servicing to request an extension so they have time to sell the home or make other arrangements as there is a robust system in place to give the estate an extension and time to sell the home or arrange alternative financing if they want to keep the home.
Pro #7. Buy a New Home Using the Reverse For Purchase Option
Many people have no idea that a reverse mortgage can be used as a home buying loan. For people who want to downsize or even upside this is a dynamic way to buy a home as an alternative to a cash purchase loan with a traditional conventional loan. The funds from the reverse mortgage are used to complete the purcase of the next home and the borrower gets all the benefits, security and features of a reverse mortgage.
Reverse For Purchase Works Well For People Who Would Like To:
- Downsize into a smaller or single level home
- Relocate closer to family or friends
- Move into a 55+ community for an active adult lifestyle
- Lower overall cost of living expenses
- Rebuild their nest egg
Reviewing the Drawbacks or Negatives of a California Reverse Mortgage
7 Cons of a Reverse Mortgage
Exploring the cons of a reverse mortgage is crucial for making a well-informed financial decision when exploring a reverse mortgage and understand the potential downsides as well.
Con #1. Loan Balance Gets Larger Over Time
A reverse mortgage by its very nature amortizes in "reverse". They are what is called a negative amortization loans. This means every month the outstanding interest and fees are added to the current loan balance. Over time the loan balance will get bigger similar to how interest compounds but in this case as loan balance lability instead. A loan that increases over time will mean the loan balance in 5 years, 10 years or 20 years from now will be larger than it is today. A lot of factors come into play here including how much of the line-of-credit or reverse mortgage proceeds the borrower uses. An increasing loan balance can eat into home equity over time. The borrower can choose to make payments on the reverse mortgage at any time, however the vast majority of borrowers never do as they want to take advantage of the no monthly mortgage payment benefit.
FACTORS TO CONSIDER HERE: While the loan balance will get bigger over time unless the borrower makes payments, real estate tends to also appreciate over time. Think back to when you may have bought your house and how much it has gone up in value over the years. While your loan balance will increase with a reverse mortgage - most likely the value of the home will in the long run too - so one may partially offset the other. The amortization schedule on the reverse mortgage proposal will help illustrate how this could potentially look over time. A skilled reverse mortgage loan officer should be able to help navigate and explain this so you can see estimated projections into the future - we are happy to provide one to you.
Con #2. Closing Costs Can Be Higher Than a Traditional Mortgage
Reverse mortgage fees are often considered higher than other types of mortgages. The fees and closing costs encompass various costs, including origination fees, mortgage insurance premiums, and servicing fees, which can significantly impact the overall expense of the loan. Additionally, interest accrues over time, further increasing the total repayment amount. Fortunately, most of the closing costs can be financed into the reverse mortgage loan. While these fees provide access to unlocking one of the most powerful and dynamic home equity products on the market, it's prudent for borrowers to carefully evaluate and understand the cost structure to ensure that a reverse mortgage aligns with their long-term financial goals and needs, and consider both the benefits and the associated expenses. As with most things in life, there is a balance between the cost and benefit and that's something that applies when considering a reverse mortgage.
Alternative to Consider With Lower Closing Costs: The Proprietary or Jumbo Reverse Mortgages
While the FHA-insured HECM reverse mortgage has some incredible benefits, one of the drawbacks is the upfront 2% MIP - mortgage insurance premium. In most cases this is by far the largest component of the closing costs. As an alternative, there are now some very dynamic alternative proprietary reverse mortgage products on the market that do not have the mortgage insurance fees that the HECM can do. The closing costs on the proprietary reverse mortgage can often times be significantly lower than a HECM. Request a quote on both today so you can compare them side-by-side.
Con #3. Could Impact Needs Based Benefit Programs
Reverse mortgages are loans and not considered income. There is no tax liability for funds drawn from the reverse mortgage. A reverse mortgage will not impact things like pensions, regular social security retirement income or even Medicare.
However there should be special consideration if a person is on a needs based program such as food stamps, Medi-Cal or disability. Some of those programs have asset limitations where the person is not allowed to have liquid a certain amount of money. Drawing large amounts of money from the reverse mortgage and holding them in a liquid checking or savings account could impact a needs based benefit program. Its important to know the program rules before you secure the reverse mortgage.
There is a proper way to navigate reverse mortgages with a needs based benefit and many borrowers have been quite successful having both. What is involved is getting advice from an expert in that area or consulting the benefit program itself. The borrower is advised to consult their program advisor to be sensitive to the asset limitations. The two can be compatible but its important to know the program rules if you are on those benefits. If there is an asset limitation - then the borrower should keep the funds in the line-of-credit and not in checking or savings. That way they have a successful experience with both the reverse mortgage and the benefit program they are on.
* Not financial advice - the borrower should consult an expert on the program benefit or another trusted advisor.
Con #4. Important To Understand Non-Borrowing Spouse Rules
To be a borrower on a HECM reverse mortgage, all borrowers must be 62 or older. If one spouse is under 62 they cannot be a borrower and they are considered a Non-Borrowing Spouse (NBS). HUD created some rules a number of years back to help protect the NBS, however if one spouse is not old enough or eligible to be a full borrower with full borrower portions it is key to understand the NBS rules. If the rules for the NBS are not followed, the younger spouse might be impacted or even forced to leave the home if the older borrower dies or goes to a nursing home. Older reverse mortgages prior to 2015 had no NBS protections in place so the industry and HUD have worked hard to make the product safer today.
Selecting an experienced loan officer who can explain the in's and out's of the NBS rules is key. Shopping around for the best deal on the reverse mortgage in terms of costs and rates is always prudent, but the experience of who you are getting information about reverse mortgage does make a difference. Prior to securing a reverse mortgage all borrowers including the NBS - non-borrowing spouse must conduct counseling with a HUD approved counselor who can also help address questions related to the NBS rules.
POSSIBLE TIP FOR NAVIGATING NBS RULES - CONSIDER A PROPRIETARY REVERSE MORTGAGE WHERE MIN BORROWER AGE IS ONLY 55
Con #5. Risk of Foreclosure
A Reverse Mortgage is a mortgage. All mortgages have the possibility of foreclosure. The borrowers must meet the loan terms. While a reverse mortgage does not have a monthly mortgage payment requirement like a traditional mortgage does, there are still requirements. For a borrower to qualify for a reverse mortgage, they must show their capacity to manage property taxes, homeowners insurance, HOA fees, and other homeownership costs. Moreover, they are obliged to maintain the home as their primary residence for the majority of the year. If, at any point during the loan period, the borrower becomes delinquent on these expenses or spends most of the year residing elsewhere, there is a potential for defaulting on the reverse mortgage, which could lead to the loss of their home through foreclosure.
Con #6. Bad Actors Who Prey on Seniors
Vulnerable seniors can become targets for individuals seeking to exploit them in many ways or scams. Some bad actors will encourage them to fall for dubious investments or encourage an older person to get a reverse mortgage so they can control their funds. This can happen with with a struggling family member, unethical caregiver and others with malicious intentions. Unfortunately, there are many instances of reverse mortgage funds being mismanaged or lost often result from poor decisions regarding how the money was utilized or invested, rather than any inherent flaw in the reverse mortgage itself. Elder abuse has become far too common these days.
John Correll, CRMP has very high client satisfaction - visit our testimonial page:
Con #7. Reverse Mortgages Can Be Complex or Overwhelming to Understand
A reverse mortgage can be a valuable tool but at the same time there is a lot misinformation float around and can be the loan itself can be difficult to understand. Many people don't understand how they work and there is a lot of paperwork involved in securing one for yourself. Some of the reverse mortgage terminology may seem foreign and intimidating. There are also important rules that need to be followed and things to be aware of. Unfortunately there are a lot of inexperienced loan officers who branch off into reverse mortgages but don't specialize in them. They can unintentionally give bad information out to a potential borrower.
Experience and knowledge are key in selecting a reverse mortgage loan officer and company.
John Correll has over 25 years mortgage experience, holds the designation of CRMP which stands for Certified Reverse Mortgage Professional. John has dedicated his career to reverse mortgages and has done hundreds and hundreds of reverse mortgage transactions. He has a deep commitment to providing quality education on everything related to reverse mortgages and can answer every question you have related to them. If you are looking for a true specialist committed to providing accurate information about reverse mortgages in an easy to understand manner - we encourage you to give John Correll a call. (888) 603-1550 or (619) 294-9820.
Summary:
Understanding the Advantages and Risks of a Reverse Mortgage in California
I hope you have found value in this overview of the pro's and con's of the reverse mortgage. As you can see there is a lot to consider when deciding if a reverse mortgage is right for you or maybe someone you care about. From someone who has been in the mortgage industry for over 25 years - I do have some advice. I highly encourage you to find a quality loan officer with a lot of experience in reverse mortgages so you can make your best decision for yourself. No question should be considered silly. If you choose to call me and work with you, I take the time to work with each of my clients, one-on-one from the initial call, through application closing and well beyond that for years to come. Unlike many of the larger companies who operate out of call centers - I never pass my clients off to the back office. Once you are a client of mine I consider you a client for life. Let's have a conversation about how home equity might help support your retirement goals.
I look forward to speaking with you.
Sincerely,
John Correll, CRMP
Certified Reverse Mortgage Professional
(888) 603-1550 | (619) 294-9820
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