Why a Reverse Mortgage is an Expensive Way to Pay Off Debt

Key Takeaways
  • Homeowners over 62 can qualify for a reverse mortgage if you have a substantial amount of equity in your home.
  • Lenders do not require a certain credit score to qualify for a loan, but you must show adequate assets to maintain the house.
  • The balance on a reverse mortgage grows each year you remain in the home, depleting your equity.
  • The lender receives a loan payoff when you sell, leave the house for more than 12 months, or pass away.

With retirement drawing near, Baby Boomers are seeking non-traditional ways to eliminate debt before entering retirement. Making minimum payments on credit card debt for the next 30 years is not feasible because it can significantly increase retirement income needs. 

One option, many seniors consider is a reverse mortgage. Unfortunately, using a reverse mortgage to pay off credit card debt is one of the most expensive solutions available.  

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What is a Reverse Mortgage?

A reverse mortgage helps those with limited financial means to remain in the home without a mortgage payment. Borrowers must be 62 or older, have a large amount of home equity, and enough financial reserves to maintain the home. The new loan must eliminate any existing mortgage. You can access the remaining equity with a loan or line of credit, based on the home’s value. The unique part of a reverse mortgage is that the interest accrues each month, resulting in a growing balance. The bank receives repayment when you sell the home.  

While it can appear to be a good idea to pay off credit card debts, here are five reasons a reverse mortgage is an expensive option for debt elimination

1)  High Costs. A reverse mortgage is an expensive loan. In addition to traditional refinance expenses such as attorney and appraisal fees, a reverse mortgage includes a high origination fee that can run thousands of dollars more than a traditional home loan.  

 

2)  It Requires a Large Amount of Home Equity. You can secure a loan through a traditional mortgage for 80% or more of the home’s value. With a reverse mortgage, the lack of payments leads to an increasing loan balance a lender must consider when approving a loan amount. In most cases, you will have access to 60 or 70% of the home’s value, with 80% being the maximum allowable amount for most loans.  

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3)  Harder to Qualify. In 2017, new laws made it more difficult to qualify for a reverse mortgage. While banks do not check your credit, they do evaluate the value of your home and existing assets to ensure you have enough resources to maintain the home and cover ongoing costs such as property taxes and insurance. Those with marginal income could qualify for a lower percentage of the home’s equity to ensure enough reserves to pay the ongoing expenses on the property.  

 

4)  Could Leave Loved Ones Without Housing. Reverse mortgages come with strict rules. For instance, only a primary residence and single-family home qualify. Homes can be up to four units and still qualify. However, most townhomes, condominiums, and mobile homes do not. 

 

To retain the mortgage, you must remain in the home. Transferring to a nursing home or living with adult children could require you to sell the home and pay off the mortgage. This feature can leave the second spouse without a place to live if they are not on the mortgage.  

 

5)  Eliminate Inheritance for Your Children. Your primary residence is often your biggest asset and can give seniors something to leave to adult children as an inheritance. Taking out a reverse mortgage will reduce or eliminate your ability to pass on your home to your children.  

If you use all your home equity to eliminate existing credit card debt, there will be no resources available to cover other emergencies down the road. A reverse mortgage is an expensive debt elimination option that can have negative long-term consequences.   

FAQs
  • Is a reverse mortgage a good way to pay off debt?

    Reverse mortgages are designed to help older people stay in their home by eliminating the mortgage. You can use the equity in your home to pay off an existing mortgage or any other outstanding debts, lowering retirement costs. However, it is an expensive way to use your home because of the high loan fees and low loan amounts.

  • How much does a reverse mortgage cost?

     Loan costs can include an origination fee of up to $6,000 plus traditional closing costs, which typically run between 2 and 5% of the loan amount.

  • Do I have to pay off a reverse mortgage?

    The lender receives a loan payoff when you sell the house, pass away, or no longer live in the home. Moving in with family members or a nursing home could initiate a sale.