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What Are Reversed Mortgages?

What are reversed mortgages?

You may have asked, “What are reversed mortgages?” after seeing an ad for these loans. If so, you’re not the only one. Many consumers don’t understand reversed mortgages, also known as reverse mortgages. A report by the Consumer Financial Protection Bureau found that misleading ads can give consumers the idea that reverse mortgages are cheaper or less risky than they really are, as the New York Times notes. And some ads don’t even state clearly that reverse mortgages are loans.

Taking out a reverse mortgage entails some significant risks, so it’s important for consumers to look past the cheery advertising and learn how reverse mortgages work.

What Happens When You Take Out a Reverse Mortgage

A reverse mortgage is a loan available to people over age 62 who live in their own homes, as the Federal Trade Commission explains. The lender gives the homeowner a cash payment every month; in exchange, the homeowner gives up equity in their home. When they sell the house, or even if they move out without selling, he or she has to repay the loan. Someone who inherits a parent’s house that has a reverse mortgage can keep the house only if he pays the amount owed; if they can’t pay it, the house must be sold.

Now that you know the answer to the question “What are reversed mortgages?” it’s time to look at some reasons they can be a bad deal for consumers.

The Downsides of Reverse Mortgages

Taking out a reverse mortgage means accepting several risks. The loan becomes due if the homeowner doesn’t pay required expenses like property taxes, or if the homeowner moves out. For example, an extended hospitalization could result in the loan being due earlier than the homeowner expected. Failing to meet the terms of the loan, could lead to the house being foreclosed on.

Reverse mortgages generally come with higher fees and interest rates than regular mortgages, as Bankrate reports. Some consumers take out reverse mortgages to pay for home improvements they don’t need or investment products that are too risky for them.

When a Reverse Mortgage Is Appropriate

A reverse mortgage may be appropriate in a situation where the drawbacks of these loans aren’t important or where a person decides staying in her home a little longer matters more than the financial downsides. For example, a retiree may plan on moving in with a child who has the financial resources to care for her as she gets older. This retiree doesn’t mind losing equity in her home because her child doesn’t want to inherit it. And she’s not worried about being foreclosed on because she can just move to her child’s house sooner if that happens. If she really wants to stay in her own home a few more years and needs money to cover her expenses while she’s there, a reverse mortgage could help by giving her cash now that she can later repay when she sells the house. However, even in a case like this, the retiree should check that there is no cheaper loan available before she takes out a reverse mortgage.

Don’t agree to a reverse mortgage until you’ve determined that you need the money, that you can handle the risks and that there is no better option. For some consumers, taking out a different kind of loan or selling their house sooner may be better choices than a reverse mortgage.

Image source: Flickr

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