Shopping for a reverse mortgage is different from experience with a conventional mortgage or a home equity loan. While a reverse mortgage can be a valuable source of cash for a home owner, there are also some reverse mortgage pitfalls that must be avoided. The following is a look at some common reverse mortgage pitfalls, followed by two smart shopping principles that will help you avoid these pitfalls.

Common Reverse Mortgage Pitfalls

What are some common reverse mortgage pitfalls? Consider the following:

• Mismatching the type of loan with the purpose.
• Eating up more home equity than was intended.
• Paying too much because of confusion over loan terms.
• Mixing up borrowing decisions with investment decisions.

The following smart shopping principles will help you avoid these pitfalls.

Smart Shopping Principle #1: Define Your Purpose

Defining your specific need for cash is important in determining what type of loan you should get.

For example, reverse mortgage proceeds can be received either as a lump sum or in the form of monthly payments. The expenses associated with a reverse mortgage tend to make the monthly payment approach more expensive (as a percentage of the money borrowed) in the initial years, so this approach should only be used if you anticipate a long time period before the loan is terminated. On the other hand, if you are looking for a lump sum, consider first whether a home equity loan might meet your needs, since this will allow you to rebuild equity rather than having it continue to be eroded by interest charges.

Another reason why defining your purpose should be the first step in shopping for a reverse mortgage is that if you need the money for home repairs or to make property tax payments, you may be eligible for low-cost, single-purpose loans. These are offered by state and local governments and some not-for-profit organizations.

Smart Shopping #2: Key Comparisons

Even if you are not eligible for a single-purpose reverse mortgage, you may be eligible for an FHA reverse mortgage (also called an HECM or Home Equity Conversion Mortgage). These will require that you pay mortgage insurance, but loan fees are regulated by the government, and there are no credit or income qualifications for these loans. If you have credit problems, a home equity loan may not be in the cards but an HECM could get you the cash you need.

For private reverse mortgages, both the interest rate and fee differentials come into play. Total Annual Loan Costs (TALC) is a required disclosure that will help you evaluate how interest rates and fees combine as a percentage of your loan. Private reverse mortgages generally cost more than HECMs but can make larger amounts of money available than the government-regulated programs.

Finally, a reverse mortgage should be evaluated separately from any investment product or proposal. For example, some reverse mortgage providers also sell investment vehicles such as annuities. In many cases, the return earned by the annuity is significantly less than the interest paid for the mortgage, making that combination of investment and borrowing a sure loser. If taking a reverse mortgage to make an investment, compare the expected return on the investment with the cost of the mortgage before committing to either the investment or the loan.

Sources:

Mortgagesfinancingandcredit.org

Reverse.org

U.S. Department of Housing and Urban Development