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Numerous people have gotten into trouble with reverse mortgages because they chose to take a lump sum payment and then spent the money too liberally. They then found there wasn’t enough money to cover their insurance, property taxes and bills from their homeowner’s association. This forced them to default on the loan. In last year alone, almost 10% of those with reverse mortgages were in default on their loans and had either lost or were risking the chance they would lose their homes.
Fewer lump sum payments
Last October, there were new rules put into effect that are designed to discourage people from taking a lump sum payment on their reverse mortgages. The way this works is that the amount the borrower receives is reduced when he or she takes the whole amount immediately. In fact, if you or your parents chose this option, the payout might be reduced by 10% to 18% – depending on certain factors. This means that the amount you or they would receive on a $140,000 reverse mortgage could go down to $125,000 or so in the event that you or your parents choose the lump sum pay out.
Why monthly payments are usually better
In most cases, it's better to take a reverse mortgage as monthly payments. This is especially true for those who have longer lives. The reason for this is that even if the payments, including interest, end up exceeding the home’s value, the payments will keep coming. In fact, you would still receive payments if you lived to age 100.
It will cost you
It’s important to understand that reverse mortgages can be costly. For one thing, in the case of some loans, there's an origination fee of 2.5% on the first $200,000 that’s being borrowed. There is also an upfront mortgage insurance fee that’s currently 2% and numerous other fees that can increase those extra costs by as much as $15,000 on a $200,000 loan.
There are interest charges, too
Lenders typically add an interest charge every month in addition to a servicing fee that could be as high as $35 a month. And there’s also an FHA annual insurance premium that will be 1.2% of your mortgage's balance. Given today’s rate of 5% for reverse mortgages, plus the insurance and service charge, a lump sum balance of $100,000 would increase by approximately 6.6% a year meaning that the debt would double to $200,000 in just 11 years.
It all counts
There will be less money for your heirs when the home is sold -- whether you die or move out. This is because all those charges described above will count against the residual value of the home. Plus, you or your parents will have to continue paying the property taxes, homeowner' insurance and any homeowner’s association bills. These are the continuing costs that caused many homeowners to run into problems in the past. And if you or your parents were risking default, you or they would be required to put money into escrow accounts to cover their every day expenses as well as their property taxes.
Issue not addressed
While the new rules have made reverse mortgages safer, there is one serious issue they didn’t address. This is the fact that many couples get a reverse mortgage in the name of whichever of the two is older to get the maximize payout as their benefit is based on the borrower’s life expectancy. For example, a person who is 62 years old might only get a payout of $140,000 on a home valued at $300,00, while a 73 year old would receive $147,000 and a person 82 years old would get $163,000.
The most serious danger
The really serious danger here is that when the spouse whose name is on the deed either moves into a retirement facility or dies, the lender will take the home and the surviving spouse could be out on the street. One attorney with the AARP said that she had heard from many surviving spouses that had been evicted from their homes and who hadn't even known that their names weren’t on the deed and didn't find out until their spouse died.
While a reverse mortgage could make good sense for either you or your parents, it's not something to leap into without performing due diligence first. As you have read, there are interest charges and fees involved in reverse mortgages that could spell trouble down the road. And if you're not careful, you, your spouse or your surviving parent could end up out in the cold when the lender takes possession of the house.