Reverse mortgage – the good, the bad and the ugly

by Chris Lang on November 2, 2009

Old coupleEver heard of reverse mortgage? Have heard of it, but unsure how it works? Kind of understand that it’s something retirees do, but not sure why? Here is what you need to know about reverse mortgages.

What’s a reverse mortgage?

Normally younger people need to borrow money to buy a house. Reverse mortgage is exactly the opposite – it’s a loan that people over 60 get against the value of their paid off house. There are no repayments with a reverse mortgage – this loan needs to be repaid at once when people sell their house, move to a retirement village / a nursing home or pass away. Instead of reducing the interest and the principle amount by making a repayment, the debt on a reverse mortgage keeps on growing.

The amount a person is allowed to borrow is nowhere near a 100% of their property – it floats between 15 and 35 percent, depending on their age. The younger the borrower is, the less they are allowed to borrow.

The good

Reverse mortgage gives you instant access to money. Imagine a pensioner with bad spending habits, who has credit card debt (or whatever else debt for that matter) and is living on a fixed income. There are many people out there who fit this description, and they would be facing difficulties when asked to repay the debt at once. One solution for that problem is to borrow money against the value of their house.

You can choose whether you want the reverse mortgage to complement your income (by receiving monthly payments) or to get a one-off amount and “have a party”, go on a holiday, buy a car, treat yourself to something you always wanted, but never could afford.

The bad

A person with a reverse mortgage is “spending their kids’ inheritance”. Personally I don’t think there’s anything wrong with it, but many people from my parent’s generation make a big deal of leaving inheritance to the children.

Also, anyone who’s got a reverse mortgage first and then decided to move to a retirement village may find out that they don’t have enough money left in their house. This is especially likely to happen during a period when the property prices weren’t going up.

People who are getting payments from Centrelink that are subjects to income test may lose their eligibility, because they’ve got the money of the reverse mortgage sitting in their bank account.

The ugly

If there’s no unconditional guarantee of ‘no negative equity’ in your contract – you’re in trouble. This guarantee is to make sure you never owe more than your house’ worth. Otherwise they may come and take it away and you will still owe money, which is exactly the opposite of enjoyable retirement.

Not many people know that anyone with a reverse mortgage has to pay for regular property valuations. At present they cost anywhere between $400 and $1000, a considerable amount that you can expect to be paying every three years.

Not many people know that a person with a reverse mortgage enters a contract with an obligation to do regular maintenance to the house and to get a building insurance, which otherwise are a completely voluntary things.

Any couple that doesn’t own the house jointly should know that reverse mortgage will be in one name only – so that when the home owner moves to a nursing home or dies, the house must be sold to repay the mortgage and the other partner can potentially be left homeless.

Do you have any experience with reverse mortgages? Are there more traps we need to know about?

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{ 4 comments… read them below or add one }

Trust deeds November 20, 2009 at 11:43 pm

This is similar to taking a loan on a deed of trust although the difference is it has to be paid up immediately.

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Isaac February 3, 2010 at 5:21 pm

VEry informative post! Learned a lot. Thanks!

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Homes in Palmdale September 17, 2010 at 1:43 am

The reverse mortgage has a lot of possible consequences that are pretty scary. I can see the benefit in them, but I don’t like how banks and other financial agencies take advantage of an opportunity to make money off the elderly that can easily leave them homeless if the market should change. Call me idealistic, but I don’t think things like that should happen to people who have worked hard their whole lives. I’m glad you are here informing everyone.

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Lyn R. Link December 9, 2010 at 2:37 pm

Great article. We just completed a book titled Reverse Mortgages: The Good, The Bad, & The Ugly written by the Reverse Mortgage Critic who has 22 years experience in the industry. Some sections include: Avoid The Reverse Mortgage Trap, Prevent Your Families’ Shock and Harm, Reverse Mortgage Lenders Steering for Profit’s Sake, and a lot of information that lenders won’t tell you but that you must know.

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