5 Biggest Mistakes People Make With Reverse Mortgages

Reverse mortgages can provide a source of supplemental income to eligible retirees by allowing them to tap into home equity. Unlike a home equity loan or home equity line of credit (HELOC), no payment is due on a reverse mortgage balance as long as the borrower continues to use the home as a principal residence. Though that might sound appealing, it's important to be aware of the most common mistakes to avoid with reverse mortgages.

How Reverse Mortgages Work

At first glance, a reverse mortgage may seem similar to a home equity loan or HELOC, but they don't work the same way. With a reverse mortgage, a homeowner is able to withdraw equity from their homes, typically either in installments or a lump sum. As long as they live in the home and use it as a primary residence, no payment is due on the balance, which accrues interest and fees. When the homeowner ceases to use the home as a primary residence, the full balance becomes payable.

Reverse mortgages that are backed by the federal government are called home equity conversion mortgages (HECMs). This type of reverse mortgage has specific guidelines regarding eligibility. To qualify for an HECM, homeowners must:

• Be 62 or older
• Own their home outright (or have paid off most of their mortgage)
• Have financial resources that would allow them to pay for property taxes, insurance, maintenance, repairs, and upkeep
• Not be delinquent on federal debt
• Attend approved reverse mortgage counseling

HECMs have closing costs that apply, and homeowners must also pay mortgage insurance premiums (MIPs) because these are Federal Housing Administration (FHA)-backed loans. Eligible property types include single-family homes, two- to four-unit homes when the homeowner lives in one of the units, HUD-approved condominium projects, FHA-approved individual condos, and FHA-approved manufactured homes.

Common Reverse Mortgage Mistakes

The decision to get a reverse mortgage can financially affect you and potentially your spouse and heirs. So it's important to know what mistakes to watch out for when applying for a reverse mortgage or HECM.

Mistake No.1: Withdrawing more equity than you need

The amount of equity you're able to tap into using a reverse mortgage can depend on your home's value, your age, and current interest rates. The equity you withdraw must be repaid with both the interest and fees added. For that reason, it's a mistake to overdraw more equity than you need.

Even if you don't have to repay that balance yourself because you pass away, the amount doesn't disappear. Your spouse or heirs would still be responsible for repaying the balance. In the absence of other assets, they may be forced to sell the home in order to clear the reverse mortgage balance.

Mistake No.2: Failing to pay property taxes and insurance

An HECM requires the homeowner to remain current on their property taxes and homeowners insurance. If you have an HECM and you fall behind on either of these payments, the reverse mortgage balance becomes payable in full immediately.

That could become a problem if you don't have sufficient cash in reserves to cover the balance or you have to drain your savings to pay it off.

Mistake No.3: Not planning for a spouse's needs

Getting a reverse mortgage while married can have implications for your spouse if they outlive you or you have to move into long-term nursing care and they're not listed as a borrower on the loan. In the case of a home equity conversion mortgage, the U.S. Department of Housing and Urban Development (HUD) distinguishes between eligible and ineligible non-borrowing spouses.

Eligible non-borrower spouses may be able to remain in the home without having to pay anything toward the reverse mortgage if the borrower spouse moves out or passes away. Ineligible non-borrower spouses do not have this protection, meaning they would need to pay the reverse mortgage balance to remain in the home.

If you're married, it's important to consider how a reverse mortgage might affect your spouse's ability to stay in the home if they're not listed as a co-borrower. You may consider purchasing a life insurance policy and naming them as the beneficiary so they have cash available to pay the reverse mortgage balance should something happen to you.

Mistake No.4: Not telling heirs about a reverse mortgage

If you plan to leave your home to your children or other heirs, failing to tell them about a reverse mortgage beforehand can result in a nasty surprise after you pass away. Again, if they cannot find the financial resources to pay off the reverse mortgage balance, they may have to sell the home. Talking to your heirs about the details of your reverse mortgage can help them to prepare a contingency plan for how to handle it after you're gone.

Mistake No.5: Not shopping around for a reverse mortgage

There are a number of reverse mortgage companies out there, but they're not all created equally. Before applying for a reverse mortgage, it's important to compare the options so you understand how much you might be able to withdraw from your home equity and what fees and interest rates may apply. You can shop for the best reverse mortgage companies online, and it can also be helpful to compare ratings with the Better Business Bureau (BBB) before choosing one.

The Bottom Line

A reverse mortgage can provide a steady stream of income to older homeowners, though it's important to understand how they work to avoid potentially costly mistakes. Talking to a reverse mortgage attorney or financial advisor can help you gain a better understanding of reverse mortgages. A reverse mortgage counselor can also help you to evaluate alternatives that may better fit your situation, such as a home equity loan or line of credit.