How homeowners can go back into debt, lose their home, and pay for the privilege

I’ve long said that if they are advertising something, you don’t need it. This was one of my very first blog posts from years ago, and I stick by it.

Now “need” is different from “want”, of course. You may decide that you want to acquire or experience something that was advertised to you. But it’s still not necessary.

I’d like to add a corollary to this though: if a celebrity is advertising something, not only do you not need it, but you probably don’t want it either.

This sprang to mind recently as I noticed a trend in how a particular product is marketed: the reverse mortgage.

The reverse mortgage explained

The reverse mortgage is a financial instrument that allows homeowners of a certain age (over 62 in the U.S. at time of writing) to take out a loan against their home. This takes the form of periodic cash payment. The loan is unique in that it doesn’t need to be paid back on any ongoing schedule.

The obvious benefit of this is that one can receive a regular “income” from assets one already owns. So it feels kind of like passive income.

The obvious drawback is that you are also willingly mortgaging your home and your future, with potentially heartbreaking consequences for you and your heirs.

That we even have to consider this question is heartbreaking enough.

Putting the “reverse” in “mortgage”

It’s important to understand what makes this a “reverse” mortgage. In a (forward) mortgage, you take out a loan for a home, and the then submit payments to reduce and pay off the loan over a period of years. So if you reverse this, you receive payments over a period of years, which grows a loan on the home over a period of time.

So even though you think you are receiving money, you are in fact just taking out a loan. It’s no different than getting a cash advance from a credit card. You didn’t actually earn anything, and you have to pay it back. With interest.

This is not a good thing. After a lifetime of moving from debt to wealth, reversing anything about this course is a clear backward step.

And it’s dangerous too, in the way that all (secured) debt is dangerous: when you have a secured asset, you run the risk of losing it.

The literature of reverse mortgages are quick to ensure that you continue to own your home and that you can’t lose it. But this is an obvious conceit. I own a home, and if I stop paying my mortgage payment, I could easily lose my home to foreclosure.

But I could also lose my home to foreclosure if I stopped paying property taxes or homeowners insurance too. Those with a reverse mortgage are no different.

And if you get foreclosed on and have to move, things can get ugly fast.

Where the reverse mortgage ends

Indeed, the piper need to be paid at some point. You will need to pay off the loan in a few situations:

• The property is sold or changes hands. This makes sense; if it’s not your property, it’s no longer a secured loan, so it’s got to go.
• The borrower has died. This is a special case of the above, since the property will necessarily change hands.
• The borrower loses the home to foreclosure due to unpaid bills such as property taxes. Again this is another case of the property changing hands.

And when any of this happens, the loan needs to be paid off immediately. No more payment plans here.

Think about it: If you were “earning” $500 a month for 5 years under a reverse mortgage, you’d have $30,000 to pay off, plus all the interest. And you’d need to pay it off immediately. Or, if you’d passed on, your heirs would need to pay this off, usually by selling the home.

Is this really how we want the final act of our financial lives to go?

How did we get here?

The reverse mortgage is nothing new, granted, having first showed up in 1961.

But like all of these schemes, there is money to be made in preying on marketing to the confused and the disadvantaged. And the middle aged and the elderly are a perfect target here, as they are more likely to own their home outright while having a less than sufficient income in retirement.

That’s an incredibly scary situation to be in. And if one has paid off the home, it can be tempting to think that one could tap its value to make ends meet.

I don’t fault people in this situation for feeling this way. But the response isn’t to re-mortgage the home, it’s to get out of the home. If you have enough equity to take out a reverse mortgage, then you likely have enough money to sell the home and move into a less-expensive place, and use the proceeds of one to pay for the other.

For example: If you sold your home for $300,000 and bought a home for $200,000, that would net you up to $100,000 (depending on taxes). If you put $100,000 in a cookie jar and took $500 out each month, you could have that income for over 16 years. More if you invested the money in something reasonably low-risk.

You take my point, I hope.

Your takeaways

• If you are 62 or older, please don’t take out a reverse mortgage. There are other, better options. Explore them.
• If you are younger than 62, but have parents who are that age, please ensure that they do not take out a reverse mortgage. I know this might be a difficult conversation to have, but as heirs, you will be directly affected.
• If you are still in your working years, remember that saving for retirement is more important than paying off the home mortgage. Saving for retirement nets you income, and with income you can find a place to live. A home can’t provide you a place to live if you don’t have any income to support it.

And don’t let Tom Selleck tell you otherwise.

But enough about me: What do you think of the reverse mortgage?