Avoiding Jeopardy with Reverse Mortgages

It’s Final Jeopardy. Contestants eagerly await as Alex Trebek, the man with all the answers, smugly reads the final clue of the game.

“A type of mortgage where the bank pays you.”

Within a millisecond, the Jeopardy champion pounds the buzzer and proudly declares “Reverse Mortgage.”

After the dreaded “fail” buzzer goes off, Alex disdainfully declares, “No sorry, that is incorrect. The correct answer is “What is a Reverse Mortgage?”

In reality, this question – What is a reverse mortgage? – has been posed more and more frequently today as mature adults and baby boomers struggle with rising expenses and their adult children worry about how they can help their parents manage them.

So what exactly is a reverse mortgage?

By definition, a reverse mortgage is a type of home loan that lets borrowers age 62 or older receive cash payments based on the equity in their homes. So instead of a borrower making payments to a mortgage lender, the lender makes payments to them, hence the term reverse mortgage.

A growing trend for those growing older. 

Reverse mortgages offer some unique benefits, not the least of which is that they generally allow aging homeowners to remain in their homes (borrowers usually do not have to pay back loans until they are no longer living in their homes). Reverse mortgages can also provide a steady stream of income to help seniors manage rising expenses – a benefit that’s become increasingly attractive as cost of living and healthcare expenses have risen.

But despite their popularity, reverse mortgages come with many drawbacks, including risk of foreclosure and higher costs than those associated with traditional loans. Because of the risk involved, potential borrowers must complete a counseling program from a government-approved agency to help them evaluate the pros and cons of obtaining a reverse mortgage. And, they must be careful to avoid overzealous lenders who might try to sway them toward reverse mortgages when a traditional option, such as a home equity loan, or no loan at all, may be a wiser decision.

A model reverse mortgage success. 

If used properly, a reverse mortgage can be a very wise investment decision as demonstrated by a retired family friend. The friend had inherited an older home in an affluent community. Though he owned the home outright, the home needed major renovations, including upgrades to the electrical and heating systems. Without the savings to finance these expenses, my friend was faced with three choices: to sell the home and rent, tap into his retirement savings to pay for the repairs, or obtain a reverse mortgage. He chose the latter and received a lump sum distribution that he used to finance repairs and renovation in the home. It proved to be a wise decision as the renovations helped improve the home’s value, and of course, allowed my friend to remain in the home and avoid renting or depleting his retirement nest egg.

Not always the best move.

Reverse mortgages are not for everyone. Because of their high cost, and the risk involved with putting one’s home at risk, borrowers and their children must be careful to use reverse mortgages wisely and not for frivolous purposes. Such decisions can put a homeowner in a more tenuous situation than they were in before they sought the reverse mortgage – in real jeopardy.

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