A reverse mortgage allows senior citizens age 62 or older to establish a mortgage that pays them a monthly payment, which is based on the amount of equity in the home. In order to establish a reverse mortgage, the home is typically owned free and clear of any other mortgages or liens. At the end of the reverse mortgage term, the money has to be repaid--just as it would in a traditional mortgage. The repayment can be completed upon the death of the homeowner or when he leaves the home permanently. Typically this is handled by selling the home and using the proceeds from the sale to pay off the reverse mortgage balance. This may sound like a great idea, but there are some pitfalls to reverse mortgages that you should be aware of.
Taking out a reverse mortgage on your home can be hazardous to your financial health. First, the fees associated with establishing a reverse mortgage are high. The upfront costs and the interest that accrues on the reverse mortgage balance typically do not put the homeowner ahead, but rather behind. For example, the typical reverse mortgage borrower receives approximately $300 per month as the reverse mortgage payment. The money received by the borrower is compounded at a monthly interest rate of approximately 1 percent. In a 10-year period, this would mean that the borrower receives approximately $36,000 in total, while the ending balance owed totals close to $70,000. This means that the borrower is paying almost double the amount she is receiving.
Complex Terms and Conditions
A traditional mortgage can be hard to understand, but reverse mortgages tend to be even more complex and have confusing terms and conditions. When a reverse mortgage borrower doesn't fully understand the financial obligation he is entering into, it can be harmful to him financially and emotionally.
One problem is that some reverse mortgage lenders do not disclose all of the costs and fees (up front and on the back end) that the borrower is responsible for paying. For example, a lawsuit stemmed from a California reverse mortgage lender that charged its clients a shared appreciation fee, which automatically paid the lender 50 percent ownership interest in the difference between the base value of the home when the loan was established and the appreciated market value of the home when the loan terminates.
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Other reverse mortgage lenders require borrowers to purchase an annuity in addition to establishing the reverse mortgage. An annuity is a type of insurance, in this case using the equity in the home to pay out the monthly reverse mortgage payments to the borrower. This means that the borrower is charged the cost of the annuity immediately with compounding interest even though the annuity is not due to start making payments for a certain period after it is established.
For example, if the annuity is set up to start paying out after a six-year period, if the borrower dies before the six-year period is up, the estate of the borrower would not benefit from the annuity even though the borrower had already paid for it in full.
There are other fees charged up front and on the back end of a reverse mortgage, which makes it an even more expensive venture. Some of these fees include origination fees, points, mortgage insurance premiums, closing costs, servicing fees, shared equity or "maturity" fees and shared appreciation fees. For example, in one case against a reverse mortgage lender, it was found that 1,505 borrowers were charged tens of thousands of dollars in loan fees that were inflated by the lender.
Counseling and Safeguards
Counseling services offered by some lenders that provide reverse mortgages are supposed to safeguard the consumer from being ripped off. The problem is that the counseling offered is not conducted by an un-biased third party, but by counselors affiliated with the lenders themselves. Counseling isn't required for every reverse mortgage either, so only those lenders that choose to provide it do. This may mean that a senior entering into a reverse mortgage may not fully understand what she is getting into because the counselor may not be sharing the full details.
The Housing & Urban Development (HUD) agency estimates that hundreds of senior citizens across the country have been cheated by unscrupulous lenders and organizations offering reverse mortgages. By taking advantage of the consumer's lack of knowledge and understanding of reverse mortgages, these unscrupulous organizations get seniors to agree to reverse mortgages with unfair, illegal and harmful terms and conditions. For example, some reverse mortgage victims were charged fees up to 10 percent of their loan amount for a reverse mortgage agent to meet with them when they could have received a referral to a reverse mortgage lender from HUD free of charge.