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Ask Dave

How Does A Reverse Mortgage Work?

Chip says his grandparents are looking into a reverse mortgage. What is this, and what does Dave think of it?

QUESTION: Chip on Twitter says his grandparents are looking into a reverse mortgage. What is this, and what does Dave think of it?

ANSWER: A reverse mortgage—if you think of the name, it kind of tells you what it is—is exactly the reverse of a mortgage. What do you do with a mortgage? With a mortgage, you pay payments, and every month, you pay down principal. With a reverse mortgage, you don’t pay payments; you receive them. Every month, you go deeper into debt. You start out not so much in debt, but every month, you’re borrowing a little bit more on your home.

I do not recommend them under any circumstances. The reverse mortgage is loaded with gotchas. The interest rates that they’re calculated at are horrendously bad. They are not a good product. The concept is not extremely bad except for the fact that we’ve got old people who’ve worked their whole lives to get completely out of debt, and now what are they going to do? Some goober in the financial planning field tries to talk them back into debt. That’s enough to make you mad right there. Aside from that, the concept of every month, you’re going to get a little check and every month, you’re going a little deeper in debt on your home is probably not the end of the world if someone’s completely broke. But when you add in the fact that these things have got rip-off fees like you wouldn’t believe, interest rates are horrible, and I guess because it’s largely the elderly who are doing it, the fraud rate on these things is unbelievable. I just tell you to stay away from them.

Well, Grandma’s sitting there, she’s starving to death, she’s got no money, the house is paid for, and she doesn’t want to move. What does she do? There are two options, and none of them are good, but she’s broke. When you’re broke, you don’t have a lot of good options. One of the options is a bad option—a reverse mortgage. That’s a bad option. Another option is not as bad an option. It’s very painful to sell the home. Sell the home and buy something less expensive, freeing up some cash to eat with. That’s a possibility. Sometimes folks have to do that because they’ve not saved money. That’s not fun, and I said it out loud. But it’s not what people want to hear. People want to not save money and be broke but have no consequences from that. Even if it’s a sweet little grandma, there are consequences to that. It breaks your heart because it’s a sweet little grandma. But there are still consequences to that. For you who are 30 and listening to me, don’t be that sweet little grandma or grandpa who’s sitting there broke. There’s no need for you to be. You need to get your butt out of debt and start saving money so you’re not one of these questions later on.

What are the other options? I don’t like this option either, but before I did a reverse mortgage, I would just go take a full-on mortgage. Just borrow as much as you can possibly borrow against the house. Put that $100,000 or whatever in an investment, pay the payments out of the investment, eat out of the investment, and when the money’s gone, sell the house. When the reverse mortgage runs all the way up, they’re going to stop sending checks, too. There’s an end to this. If Grandma outlives the size of her equity in her house, either way, she’s going to have a problem if she tries to stay in this house. The house is going to leave. On a reverse mortgage, that’s what happens. When it runs up to a certain point and they pass away, then the debt is repaid. On some of the old reverse mortgages, they were really bad. They were set up on an actuarial table where when you died, the house went to the bank. And no matter when you died, the house went to the bank. That was a complete rip-off. There are still a few of those floating around out there. Stay away from those. There aren’t as many as when the business first opened with the thing.

Reverse mortgages are a bad product. Stay away. That’s the answer to your question.