A reverse mortgage can be a useful tool for homeowners who want to unlock wealth tied up in their homes without making monthly loan payments. Yet like any financial product, it comes with a series of potential pitfalls that buyers should understand before moving forward. This article looks at what a reverse mortgage is, the common risks involved, and practical guidance on comparison shopping and decision making. It also explains how you can approach the process in a structured way so you can weigh this option against other possibilities for funding needs in retirement.
A reverse mortgage is a loan secured by your home that is designed for homeowners typically aged sixty two and older. Instead of making monthly payments to a lender, you can borrow against your home equity and receive funds in one of several forms, such as a lump sum, a line of credit, monthly payments, or a combination. The loan balance grows over time as interest accrues and the outstanding balance is paid back when the borrower sells the home, permanently moves out, or passes away. Most reverse mortgages used in the United States are Home Equity Conversion Mortgages, or HECMs, which are insured by the Federal Housing Administration. While this insurance protects borrowers from owing more than the home’s value in many cases, the rising balance can erode home equity, sometimes leaving little for heirs.
One of the most important pitfalls to understand is the cost structure. A reverse mortgage carries closing costs, origination fees, and mortgage insurance premiums that can be substantial. While fees vary by lender and loan type, the total cost over time is influenced by the interest rate and how many funds you draw. Interest compounds as the loan balance grows, which means the longer you hold the loan and the more funds you withdraw, the larger the ultimate payoff — even if your home remains physically unchanged. Borrowers may see less equity available for heirs or for other retirement needs as a result. It can also be tempting to rely on a monthly advance when you do not want to change budgeting habits, but that can reduce the amount of equity left for future needs.
Another significant pitfall concerns the status of a spouse or other non borrowing residents. Depending on the structure of the loan and the borrower’s marital situation, a surviving spouse may face restrictions or even the need to settle the loan when the other borrower dies or moves out. Some programs offer protections for non borrowing spouses, but rules vary and can be complex. If the home is sold or transferred, the loan must be repaid, and in cases where the loan balance exceeds the home’s value, the FHA-backed insurance can prevent a deficiency payment from the borrower or heirs; however, the net effect is that the household equity is reduced, which may impact future plans and inheritance.
The impact on benefits and day to day finances is another area where care is warranted. Proceeds from a reverse mortgage generally do not count as income for tax purposes in the year they are received, but they can affect means-tested programs and eligibility in some cases. In addition, because the loan is secured by the home, ownership and ongoing costs such as property taxes, homeowner’s insurance, and maintenance remain the responsibility of the borrower. If those obligations lapse, the lender can demand repayment and potentially foreclose. This means a reverse mortgage is not a free pass to stop managing home maintenance or to ignore ongoing costs.
Understanding what you are giving up is crucial. Although a reverse mortgage can provide cash flow or a line of credit, it also reduces the equity that could be left to heirs or used for other financial strategies. Because the loan balance grows as long as the loan remains outstanding, you may end up with less option to move in retirement or later on. The non recourse feature of many HECMs means borrowers and heirs are not personally liable beyond the home’s value, but the ultimate effect is that you might leave less to heirs than anticipated if you stay in the home for a long period or draw heavily on the loan.
For those who are considering this path, a careful comparison of lenders and product features is essential. Major lenders and industry players in the reverse mortgage space include American Advisors Group, Finance of America Reverse, Longbridge Financial, Liberty Reverse Mortgage, and Mutual of Omaha Mortgage. Each lender often advertises a range of product options and service levels, but the differences are not always obvious at first glance. When evaluating lenders, consider the following:
- The structure of payouts: Some products emphasize a growing line of credit that increases over time, while others offer more predictable monthly cash flows or lump sums. The choice can significantly affect how much equity remains in the home years down the road.
- Upfront and ongoing costs: Request a clear disclosure of origination fees, closing costs, required counseling fees, and ongoing servicing costs. Small differences in these figures, when compounded over many years, can materially affect outcomes.
- Counseling and education: A HUD approved counseling session is typically required before closing. Use this opportunity to learn about alternatives such as traditional home equity loans, line of credit options, downsizing, or selling the home.
