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Disadvantages of reverse-mortgages

For cash-strapped seniors rich in home equity, a reverse home mortgage can provide a steady source of income. This can mean the difference between scraping pennies together or going on that dream vacation. While reverse mortgage loans are, for obvious reasons, becoming very popular these days, they do come with their own set of disadvantages.

Please do not take this the wrong way. We are not saying that you should never get a reverse mortgage. In fact, in the right situation, reverse mortgages are wonderful tools. However, it is important to be aware of the potentail disadvantages of a reverse mortgage.

Reverse Mortgage Disadvantage #1 - It Is Not Free Money

The money you get from a reverse mortgage is not free money. The lender is not giving you a reverse mortgage out of the goodness of their heart. They are in business to make money.

In a regular mortgage agreement, the lender loans you money and you are required to pay that money back, plus interest. For a reverse mortgage, the situation is a little different. You receive a cash stream from your property. When the reverse mortgage agreement is over, you or your heirs must repay all of the cash you have received, plus the interest on it.

Basically, the lender loans you money (and charges you interest on that loan) with the guarantee that they will eventually be repaid - when you sell the home, refinance, or permanently leave the home (i.e. you pass away).

Reverse Mortgage Disadvantage #2 - You Lose Equity in Your Home

You will have less equity in your home. A reverse mortgage allows you, the property owner, to access some of the value of your property without selling it. 'Equity' is the term used to describe the difference between the value of your home and how much you owe on it.

Since a reverse mortgage works on the basis of taking equity out of your house (the money you receive from a reverse mortgage eventually will be repaid out of the value of the home) - the amount of equity in your home will decrease as your reverse mortgage loan increases.

The loss of equity is not necessarily a bad thing - since you will have more cash in your pocket. It is just a trade-off. You will have to decide for yourself whether the money you will get from a reverse mortgage is worth hte tradeoff of less equity in the future.

Reverse Mortgage Disadvantage #3 - More Expensive Than Traditional Home Loans

Another of the reverse mortgage disadvantages is that reverse mortgages tend to be more expensive than traditional home loans. Why is this? Because the reverse mortgage lender assumes more risk when they offer this mortgage product.

While a traditional mortgage lender starts receiving payments from the first month the loan is given, the reverse mortgage lender may not see any return on their money for many, many years - if, for instance, you lived to be 100 years old.

For that entire time (as per the reverse mortgage agreement) they cannot require you to make any payments. Since the risk is greater, there is an increased cost associated.

Reverse Mortgage Disadvantage #4 - You Need Equity to Qualify

You usually need a lot of equity to qualify for a reverse mortgage. A reverse mortgage lender will usually loan you only about 30-80% of the value of your home. This amount varies based on your age, and the specific reverse mortgage plan you choose.

Since reverse mortgages must first pay off any existing mortgages, if you have a loan that is for a greater amount than the reverse mortgage amount you qualify for, you will need to make up for the difference from your savings. If you do not have sufficient money to bring your current mortgage balance below the maximum amount that you could get from a reverse mortgage, you will not qualify for a reverse mortgage loan.

In Summary...

Basically, reverse mortgages are the inverse of a traditional mortgage. Instead of you making payments to the lender, the lender makes payments to you. As a result, and the main disadvantage of a reverse mortgage, your debt (rather than your equity) grows over time.

Although there is no risk that you will lose your home or that your reverse mortgage loan amount will be greater than the value of your home, there is a possibility that (especially if you live to a ripe old age), all the money from the sale of your home will go to the lender.

In other words, there is a possibility that you will use up all the equity in your home. This will not matter to you - but it will decrease or eliminate any inheritance for your children.

While it is a useful tool for certain situations, many financial planners feel that tapping your home equity should only be done if you have exhausted all alternatives. It is not too surprising then that some people have said 'a reverse mortgage is a perfect strategy - if you hate your kids!'