This is my second post in my coverage of the widely circulated Consumers Union report entitled, “Examining Faulty Foundations in Today’s Reverse Mortgages.” In this post, I want to examine the section “Reverse Mortgage Pitfalls” as part of a broader examination of the risks surrounding reverse mortgages.

The report identifies a handful of specific pitfalls. First, there are suitability concerns; namely, reverse mortgages aren’t appropriate for a significant portion of eligible borrowers. According to Consumers Union, “The right reverse mortgage may be appropriate for some low-income relatively healthy seniors who lack other retirement assets, do not qualify for lower-cost alternatives and cannot meet their current mortgage obligation.” On the other hand, those whose health is questionable and/or have definitive plans to move into an assisted living facility at some point should probably avoid reverse mortgages.

Second, there are concerns over the disbursement of and use of the reverse mortgage proceeds. Some borrowers withdraw the maximum amount of equity because they think they should, rather than leaving it in a line of credit account to accumulate interest. Many borrowers also make the mistake of treating reverse mortgage proceeds as a windfall – when it is really a loan – and spend it on frivolous or lifestyle purchases, rather than on necessary living expenses.

Third, many borrowers fail to fully understand the costs of the reverse mortgage because they are deducted from home equity rather than paid directly by the borrower. Along these lines, they fail to appreciate that upfront costs are substantial, and that combined with the compounded interest on the negatively amortizing loan, their home equity may deplete itself in 10-15 years or less.

Next, some borrowers also fail to realize that a reverse mortgage can affect their eligibility for certain government benefits, such as social security and medicaid. According to Consumers Union, “A ‘lump sum’ reverse mortgage payout will immediately put the elder above the asset limit for SSI/Medicaid and disqualify the senior for these important benefits, unless careful legal planning is done to avoid this result.” Before obtaining a reverse mortgage then, all prospective borrowers should research the impact on the money they expect to receive from government entitlement programs.

Finally, due both to deceptive marketing and an inherent lack of understanding, borrowers fail to grasp that a reverse mortgage is a loan agreement, and violating the terms could result in foreclosure. For example, unlike with a conventional mortgage, reverse mortgages do not require the funding of escrow accounts to pay property taxes, hazard insurance premiums, and for routine home maintenance. It is vital that borrowers understand that neglecting to make these payments (out-of-pocket) could trigger a default on the loan and even foreclosure.

For additional information, I would encourage you to consult the Consumers Union report, and to read a couple related posts that I wrote earlier, here and here.