Reverse Mortgages: What You Really Need to Know

I’m getting a lot more questions about reverse mortgages lately. Let’s start with some basics.

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Getting a fair number of questions about reverse mortgages lately and about this shirt. Because I’m old, people figure I’ll know a lot about reverse mortgages. Hey, that’s fair. So first off, what exactly is a reverse mortgage? Well, it’s a loan made to you, the borrower, secured by equity in your home, but you don’t have to make regular payments against it.

Instead, the interest owed accrues and compounds over time. You pay the loan back when you sell, move out or pass away. When you take out a reverse mortgage, you stay in the home and you maintain ownership. And if you end up owing more on the loan than the value of the home, that’s the lender’s problem, not yours.

Hey, the no-on-going-payment part sounds like a lot of fun, doesn’t it? And, look, the ability to tap into your home equity if you need to while staying in your home — that’s appealing to many. I get that. But… there’s always a but, isn’t there? With the reverse mortgage, you turn the financial world’s most powerful potential ally, compounding, into your enemy.

Yep, compounding — named by none other than Einstein as the eighth wonder of the world, the undisputed Heavy-Weight Champion — is now entering the ring to take you on. Let’s say you’re 60. You live in a million-dollar home. You’re tight for cash, so you decide to take out a reverse mortgage for $300,000. If your borrowing rate average is 7% a year — about what some reverse mortgage lenders are charging today — the amount you owe will double about every 10 years.

(remember the rule of 72). Hmm. You live to be 90. Happens a lot nowadays. How much do you owe? Well, that’s 30 years, time enough for three doubles, 300 to 600, 600 to 1.2 million, 1.2 million to 2.4 million. Yes, that could be a big portion of your home equity but, remember, your home will grow in value too.

So, Dave, are reverse mortgages, good or bad? Neither. On the negative side, they are expensive debt that, as mentioned, can eat up a lot of your home equity over time. On the positive side though, if you’re older and in need of money, hey. You don’t wanna move out — that’s a lot of people in Canada — they are a tool worth examining.

We’re going to cover reverse mortgages much more thoroughly in an upcoming podcast, but here are five quick thoughts for your consideration: 1) Shop the market if you’re looking for a reverse mortgage. Rates and fees can vary significantly. And more lenders are entering the space. 2) Talk to your heirs.

Not that they should be able to dictate your strategy here, but communication now can save surprise and resentment later. 3) Try to deal with a lender that lets you borrow gradually. Some do. Some don’t. Obviously, a big plus here is that you keep interest costs down as opposed to borrowing everything up front.

Get to know all the rules, whatever you do. What are the minimums, the fees, et cetera? 4) Look at using a HELOC — a Home Equity Line Of Credit, instead of, or at least first. That is what most independent experts advise. We’ll get more into this HELOC versus Reverse-Mortgage debate in the podcast, but here’s one point I really want to drive home because it’s not mentioned enough.

The lending institution can reduce your credit limit at any time with a HELOC. They can even demand repayment in full with little warning, though you don’t see that much. And 5) Point last, don’t do anything in this space without getting advice from an unbiased expert. So important you understand what you’re getting into here, including the subtleties.

Do your homework. Don’t rush to sign. We’re gonna start doing a lot more, by the way, on all this retirement planning and late-life money management stuff. There are a lot of nuances here, even with the basic approaches. Stay tuned.