Reverse Mortgages: How They Work and How to Shop For One Safely
Reverse mortgages allow homeowners to unlock the value they’ve built up in their home, but their utter complexity makes them fertile ground for scammers.
Reverse mortgages might be one of the most common kinds of loans that almost no one actually understands. And that makes sense. Even the name feels like it’s pulling a switcheroo. How could someone do a reverse mortgage? That can’t be real, can it?
Well, it can! And it is! Reverse mortgages are a very real kind of loan available to U.S. seniors. But the fact that these loans are so misunderstood means that many lenders can use them to take advantage of their customers. It’s a different kind of switcheroo, and one with dire consequences.
Here at OppLoans Financial Sense Blog, we are dedicated to helping folks steer clear of predatory lenders and scammers. That’s why we’ve laid out some information about how reverse mortgages work, and what you can do to shop for one safely.
What are reverse mortgages?
A reverse mortgage is a way for older homeowners to spend the equity that they have built up in their home while still being able to live there. While a person could unlock the value of their home by selling it, that would have the downside of their having to move in order to do so. A reverse mortgage means they don’t have to to do that.
It helps to think of a reverse mortgage like a home equity line of credit (or HELOC), which allows homeowners to borrow money based on the value of their home beyond what they still owe on their mortgage. The name “reverse mortgage” comes from the fact that borrowers receive money from their lender instead of having to make monthly payments to them, the reverse of how things work with a regular mortgage.
The main difference between a reverse mortgage and a regular HELOC is that HELOCs require the homeowner to repay the money they borrow at regular intervals while reverse mortgages do not require repayment (plus interest) until the homeowner sells the home, passes away, or ceases using it as their primary residence.
Reverse mortgages are not only designed with older homeowners and retirees in mind, they are actually restricted solely to that age group. In order to take out a reverse mortgage, you must be age 62 or older. In fact, the older you are, the more you will be able to borrow. Many reverse mortgages are offered by government agencies or non-profits, but there are reverse mortgages offered by private lenders as well.
If you have ever seen a reverse mortgage advertised as “free money,” stay away from that lender. These are loans, not gifts. Borrowers will have to pay fees and interest on the money they borrow through any reverse mortgage—plus they’ll still be responsible for costs like property taxes and home upkeep. Even the safest types of reverse mortgages come with considerable risk. That’s why many view them as a financial option of last resort.
There are three types of reverse mortgages.
According to the Federal Trade Commission (FTC), there are three basic kinds of reverse mortgages:
Single-purpose reverse mortgages are the least expensive option. They’re offered by some state and local government agencies, as well as non-profit organizations, but they’re not available everywhere. These loans may be used for only one purpose, which the lender specifies. For example, the lender might say the loan may be used only to pay for home repairs, improvements, or property taxes. Most homeowners with low or moderate income can qualify for these loans.
Proprietary reverse mortgages are private loans that are backed by the companies that develop them. If you own a higher-valued home, you may get a bigger loan advance from a proprietary reverse mortgage. So if your home has a higher appraised value and you have a small mortgage, you might qualify for more funds.
Home Equity Conversion Mortgages (HECMs) are federally-insured reverse mortgages and are backed by the U. S. Department of Housing and Urban Development (HUD). HECM loans can be used for any purpose.
Since HECMs are insured by the government and backed by HUD, they come with some fairly stringent approval processes. For instance, the FTC specifies that you will need to meet with an “independent government-approved housing counseling agency” before applying for a HECM. These counselors must clearly explain the costs and implications of the loan and assess whether you, the borrower, will be able to meet your obligations.
HECMs also come with a number of different ways that your money can be disbursed to you. From the FTC:
The HECM lets you choose among several payment options:
a single disbursement option – this is only available with a fixed rate loan, and typically offers less money than other HECM options.
a “term” option – fixed monthly cash advances for a specific time.
a “tenure” option – fixed monthly cash advances for as long as you live in your home.
a line of credit – this lets you draw down the loan proceeds at any time, in amounts you choose, until you have used up the line of credit. This option limits the amount of interest imposed on your loan, because you owe interest on the credit that you are using.
a combination of monthly payments and a line of credit.
You may be able to change your payment option for a small fee.
While there are certainly a lot of strings tied to HECMs, most of those are in place to protect borrowers. Reverse mortgages are fairly complicated (you probably clicked on this article because you were looking for more info about them) and those complications can make them fertile ground for scammers.
Watch out for predatory reverse mortgage lenders.
Reverse mortgages have exploded over the past 20 years, and with the Baby Boomer generation entering their golden years, that popularity is only going to increase. With the reverse mortgage boom has come a number of lenders that seek to take advantage of prospective customers.
These loans make a great habitat for predatory lenders and outright scammers for two main reasons. First, reverse mortgages are much more complicated than traditional loans. That makes it easier to bury red flags under a mountain of fine print. Second, these loans are only available to seniors, and scammers love taking advantage of seniors.
According to a 2016 study from the Consumer Financial Protection Bureau (CFPB), a vast number of reverse mortgage advertisements left consumers with false ideas of how these loans work. Impressions that these loans were a “free government benefit” and would grant borrowers financial security for the rest of their life were common. The study even found many consumers who watched these ads and were confused that reverse mortgages were, in fact, a type of loan!
If you are a senior considering a reverse mortgage loan, make sure you do the following:
- Shop around. Do not say yes to the first reverse mortgage that comes your way. Make sure that you are finding the best possible loan available.
- Don’t listen to ads or salesmen. Instead, make sure you to talk to certified financial professionals who can clearly explain the pros and cons and walk you through the fine print.
- Avoid seminars and people who approach you in social settings. A seminar is almost guaranteed to not give you the whole story, and people who offer reverse mortgages in social settings might very well scamming you. Or they are salesmen. Either way, don’t trust them!
- Bring a buddy. A reverse mortgage is a big enough financial decision that you do not want to make it alone. Bring a child, niece or nephew, or a good friend along with you to any meetings you take and also have them go over the documents with you in private. Reverse mortgages are complex; you’ll need all the help you can get.
- Avoid reverse mortgage “investment opportunities.” This is an out-and-out scam where a con man gets seniors to take out reverse mortgages and “invest” the money with the scammer, who then takes the money and either runs or spends it on himself. Even if the person is using your money to make “legitimate” investments, these schemes should still be avoided at all cost.
- Take your time and don’t sign anything you don’t fully understand. This advice holds true for every type of loan, but it goes doubly so for reverse mortgages. Don’t let a salesperson or even a financial advisor rush you through the lending process. If you do not understand your contract, have someone you trust (and who doesn’t stand to gain anything from you taking out or turning down the loan) to review it and explain it to you. An extra week or two right now could save you years of financial hardship down the line.
Contrary to what some folks will tell you, reverse mortgages are not predatory by nature. Like bad credit loans, reverse mortgages are a legitimate financial tool, even if some sketchy lenders out there are offering them irresponsibly. When used in the right way, a reverse mortgage can help seniors unlock the wealth they have spent a lifetime earning.
However, there are enough reverse mortgage lenders out there whose tactics are predatory that you should treat any reverse mortgage offer with extreme skepticism. Basically, they’re a scam until proven otherwise. When taking out any kind of personal loan, you need to do all your homework before making your decision.
To learn more about how you can protect yourself from predatory lenders, check out these related posts and articles from OppLoans:
- A Field Guide to Spotting Predatory Lenders
- Make Sure Your Bad Credit Loan Has Payments You Can Afford
- Loan Scams: 6 Warning Signs You Need to Know