Understand downsides to reverse mortgages

Celebrity spokesmen routinely appear on television — as well as in direct mailings — to explain the merits of reverse mortgages to those 62 years of age or older. While on the surface they seem irresistible, there are downsides that potential borrowers should understand.

Let’s briefly review the concept of reverse mortgages as well as their potential pitfalls. Reverse mortgages are typically restricted to seniors who have built up substantial equity in their homes and want to convert this into cash.

In exchange for the equity in their homes, borrowers receive cash in the form of monthly payments, lump-sum distributions or a combination. Reverse mortgages can be used to supplement retirement income, pay medical expenses or maintain property.

Seniors should realize that in exchange for the funds, they will incur interest charges, insurance payments,and servicing fees. The mortgage must be repaid after the borrower dies, sells the home, fails to pay property taxes or insurance or allows the home to deteriorate substantially.

For reverse mortgages to be effective, homeowners must understand them, and lenders must correctly underwrite them. But studies indicate that seniors often are poorly counseled and do not understand the requirements of reverse mortgages.

Much of the concern among regulators relates to advertising “pitches” that portray reverse mortgages as income for life that never has to be repaid. Moreover, reverse mortgages often involve high origination fees and large insurance and servicing charges that exceed other financing options available to seniors.

Typically 5 to 6 percent of the home’s value, fees may amount to thousands of dollars, and they are usually added to the amount of the loan.

Regulators note that financial institutions should explain not only the advantages but also the pitfalls associated with reverse mortgages prior to taking an application. They are complex financial products that require time and detailed counseling.

Keep this in mind if you are a candidate for a reverse mortgage.