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Reverse Mortgage Pitfalls that You Should Be Aware Of

Although a reverse mortgage is a good opportunity for senior citizens to convert some of their home equity into cash, it is important to be aware of the potential reverse mortgage pitfalls before entering into an agreement.

Homeowners over the age of 60 can avail a reverse mortgage as a means of raising money against equity in their home. The reverse mortgage is calculated on the debt free portion of the house value and typically covers up to 40% of this value. Retired homeowners often find this option attractive because there are no periodic repayments involved. The loan is paid back from the sale of the property only after the death of the homeowner and the balance is paid to the heirs.

Keep an Eye on the Costs

Homeowners need to be aware of the higher costs that reverse mortgages often entail. Here are some of the costs that you should consider carefully in a reverse mortgage agreement:

  • Interest: Reverse mortgages often come with higher interest rates than conventional mortgages. In addition, as no repayments are made on the debt, the compounded interest over a long period is significantly higher than the interest that you accrue on a mortgage with regular payments.
  • Fees: Processing fees may include home appraisal fee, closing fee and application fee. In addition, a legal fee may also be charged.
  • Penalty: While this cost will not arise immediately, you should keep in mind that a penalty will be charged if you wish to sell the house or move to a different house at some point.
  • Clearing Previous Debts: As a reverse mortgage is essentially an advance on the value of your house, the lender may require you to pay off any previous debts that use your house as collateral. This may be done with the funds brought in by the reverse mortgage but it will reduce the cash you get in hand. You will also have to pay the fees for closing these existing debts.

You Leave a Smaller Legacy for Your Heirs

Another disadvantage associated with reverse mortgage is that it significantly reduces your equity in the house over time. Your equity diminishes as the accrued interest goes up year after year. When this interest is recovered along with the rest of the loan, by selling the house after the homeowner’s death, it might not leave much to be given to your heirs. The larger the loan, the faster the equity in the house will erode, unless capital appreciation in the property can set off this erosion.

However, all these disadvantages should not lead you ignore the benefits of reverse mortgage. With these loans, you can utilize your property to bring in cash when you need it most, without having to sell the house. The money that you get from the loan is tax-free and you can use it in whichever way you want to. The important thing is to weigh the reverse mortgage pitfalls against all the benefits that you get, and then make the right financial decision.