For those unlucky borrowers that took out reverse mortgages prior to the housing crisis, many have seen the equity in their homes collapse, to the point where some of their reverse mortgages are fully underwater. As a result, such borrowers are basically just squatting in their homes, continuing to pay property taxes and insurance, despite the fact that they own 0% of their homes.

While it’s unclear how widespread this phenomenon is, given the FHA’s recently announced financial troubles (the FHA insures the majority of reverse mortgages), one can safely surmise that a growing portion of reverse mortgages were characterized by negative equity when they were closed out. That also implies a growing quotient of borrowers that have left their homes after the expiry of their mortgages without receiving even a penny.

That’s not to say that this phenomenon is improper, or even unfair. After all, the terms of the reverse mortgage are such that the borrower’s equity is by definition, the value of the home minus the value of the reverse mortgage. If the value of the mortgage rises faster than the value of the home, then the borrower could quickly find himself without any equity left in the home. For long-term reverse mortgage borrowers – those that plan to remain in their homes until their passing – this shouldn’t be much of a problem, since the swings in real estate values will offset each other over a couple decades. For those that saw the quick cash offered by a reverse mortgage without fully understanding the terms,
this must be devastating.

In addition, as advocates of reverse mortgages have pointed out, the decline in equity would have affected the homeowner regardless of whether a reverse mortgage was in place. Critics argue that failure to pay property taxes and insurance could lead to foreclosure by the reverse mortgage lender, but to be fair, this would also be the outcome even in the absence of a reverse mortgage. The difference can be found in the high upfront costs and annual interest/insurance payments that quickly erode one’s equity under a reverse mortgage.

Going forward, it’s reasonable to expect that home prices will rise again at some point in the future. However, it’s not a given that prices will rise faster than rates, currently about 6% for a reverse mortgage. That being the case, in increasing portion of borrowers could find themselves with vastly depleted equity when it comes time to leave their homes. For that reason, it’s recommended that only borrowers with other reserves take out reverse mortgages. Even if you plan to remain in your home until the proverbial “last minute,” the possibility of unforeseen events (i.e. illness) should make you think twice.

In short, when you obtain a reverse mortgage, you should conservatively assume that when you ultimately move out of your house, you won’t have much equity left in it. If this proves to be the case, consider yourself prescient. If not, well, then you will reap a minor windfall from the sale of the home, which you can put towards other living arrangements.