A GUIDE TO REVERSE MORTGAGES
A reverse mortgage is a type of loan that allows homeowners to borrow money against the equity in their homes. Reverse mortgages enable homeowners to tap into a line of credit or receive from a lender a fixed monthly payment that can help them pay off debts, make upgrades to their property, manage large expenses, or supplement their retirement income.
A reverse mortgage will not exceed the value of the home over the life of the loan, and unlike a traditional mortgage, a reverse mortgage loan does not need to be repaid immediately. Payments on the loan do not begin until the borrower dies, sells the home, or moves away. Homeowners considering a reverse mortgage for themselves should consider all of the factors—and compare offers from a number of lenders—before deciding whether or not a reverse mortgage is right for them.
Although reverse mortgages do allow borrowers with equity in their homes to access credit when it’s needed, this type of loan can have a big impact on their legacy. For this reason, seniors who want to keep their home in the family or who would like to leave a large sum to their heirs may not consider this type of loan to be an acceptable option. If you are a senior who is considering getting a reverse mortgage or a conversion mortgage, understanding the basics can help you decide if this type of mortgage is right for you.
Understanding A Reverse Mortgage
Under traditional mortgages, buyers borrow money from lenders to purchase a home. Once the money has gone to the seller and the home is purchased, the homeowner begins to make a monthly mortgage payment to the lenders for the loan. With each mortgage payment that is made, the borrower builds equity. Home equity increases over time. When the mortgage has been fully repaid, the homeowner owns the house outright.
A reverse mortgage is very different. Under this type of mortgage, the lenders decide how much the borrower can take out based on the current value of the home and the borrower’s current equity. The lenders then make monthly payments to the borrower, or else the lenders provide the borrower with a line of credit or a lump sum payment. Sometimes borrowers get a combination of these options.
Even after the payments are under way, the homeowner keep possession of the house and the title. But the lender will calculate interest (often at a variable rate) on all money paid out to the homeowner. This interest will compound as the life of the loan progresses until the loan is fully repaid. Even though interest continues to accrue, however, the loan balance can never exceed the value of the home. If the borrower ends up receiving more money than the home is worth, the reverse mortgage lender will still only recover whatever money they make when the home is sold.
As payments are made to borrowers, the equity in the home decreases. If money is left over when the home is sold and the bank has recovered the loan amount, the lender pays this balance to the heirs of the estate.
Reverse mortgages have been used to pay for a variety of homeowner expenses and fees over time. While some seniors may use their reverse or conversion mortgage to pay for property taxes, upgrades, home improvements and other large expenses, other seniors may use their reverse mortgage to tap their equity while they’re still alive to live more comfortably or pay for medical expenses without risking foreclosure.
How Does A Reverse Mortgage Work?
Reverse mortgages are only available to homeowners 62 and older. In addition, borrowers can’t qualify for a reverse mortgage without passing a financial assessment to determine whether or not they’re able to keep up with property taxes, insurance and other financial obligations. If the borrower fails to make insurance and property tax payments during the life of the loan, the loan may become void and the borrower stands to lose his or her house.
The amount the lender loans to the borrower depends on the amount of equity the homeowner has in his or her house. Borrowers are given monthly mortgage payments from the lender, or may take out of the loan balance a lump sum for expenses (including home expenses like property taxes). Unused portions of the loan will increase in value over time, so borrowers can take advantage of a larger sum of money as time goes on.
This type of loan is only available for primary residences, and cannot be used against a vacation home or a home that has not been occupied for more than a year. Borrowers who move out of their home after taking out a reverse mortgage can wait up to one year before it is time to pay the loan to the lender. Reverse mortgage loans are a solid option for homeowners who have built up a significant equity in their home over time.
Types Of Reverse Mortgages
There are four different types of reverse mortgages: single-purpose, proprietary, and FHA-backed reverse mortgages offered under the Department of Housing and Urban Development’s HECM program. Typically, the type of loan that a borrower gets depends on the borrower’s qualifications, the reasons the borrower needs the loan, and the borrower’s financial health when the loan is made.
Minimum Age Required to Obtain a Reverse Mortgage
Under this type of mortgage, the lenders decide how much the borrower can take out based on the current value of the home and the borrower’s current equity.
Single-Purpose Reverse Mortgage
A single-purpose reverse mortgage is a loan that is made for a specific purpose, such as a home improvement loan or to pay off a debt. Single purpose reverse mortgages are the least expensive form of reverse mortgage, and are typically made available to homeowners from state agencies and local non-profit groups.
Proprietary Reverse Mortgage
Proprietary reverse mortgages are loans made through private lenders. Proprietary reverse mortgages are most often made available to homeowners who have expensive properties and who owe little on their home. The less that a homeowner owes, the more he or she will be able to take out when the loan is made. Proprietary reverse mortgages are typically made to homeowners who need a large infusion of cash and are hoping to take it out in a lump sum.
Home Equity Conversion Mortgage (HECMs)
A home equity conversion mortgage, or HECM loan, is a home-equity loan that is backed by the U.S. Department of Housing and Urban Development (HUD). Home equity conversion mortgages are FHA loans and are only available through FHA-approved lenders. A borrower using one of these HUD-backed loans will have access to many different types of payment options through the HECM program, including monthly cash advances or a line of credit. Borrowers who have more equity in their home and who are older are given access to more money than homeowners who are younger and who have access to less equity.
Why Should I Or My Loved One Consider A Reverse Mortgage?
A reverse mortgage loan can have many benefits for the right borrower. Reverse mortgages enable homeowners who are barely scraping by on their current income to enjoy a more comfortable lifestyle. Retirees who want to check items off of their bucket list can do so with the help of a reverse mortgage. In addition, many borrowers can use their reverse mortgage loan balance to pay off their existing mortgage, which frees up more money for other expenses. For homeowners who are receiving help from adult children, the monthly payments from a reverse mortgage can help borrowers remain independent and live comfortably at the same time.
For homeowners who wish to delay drawing social security benefits, reverse mortgages can help make this possible. Finally, most reverse mortgages can be used for any purpose, which means that borrowers are able to use the funds at their discretion as the need arises. For borrowers who are 62 years old or older and who need a little more money to live comfortably in retirement, a reverse mortgage is an excellent option.
In addition, since counseling and assessment for potential borrowers is required, reverse mortgages are a relatively safe type of loan. The assessment helps ensure that this type of loan represents minimal risk to the borrower. Counseling helps ensure that borrowers understand the way a reverse mortgage works and what they can do to get the most out of their mortgage. Borrowers who go through counseling and decide it’s not for them can always back out before finalizing the paperwork.
Pros and Cons, Risks and Rewards
There are many pros and cons of reverse mortgages. Pros that can attract borrowers to reverse mortgages include:
It’s easier to qualify for a reverse mortgage than for a traditional mortgage.
Reverse mortgage payments don’t need to be repaid during the lifetime of the borrower unless the borrower leaves his or her house.
Reverse mortgages help seniors in need of more cash to make property tax payments, pay their mortgage loan balance, or pay for long-term care and other major expenses.
Income from reverse mortgages is not taxable.
Unfortunately, there are some downsides to reverse mortgages. Extra fees and other costs can make this type of loan more expensive than it appears on the surface. Some of these fees can be avoided if the borrower takes out the loan in the form of a credit line rather than a lump sum payment. By taking out a line of credit, borrowers only pay interest on what they’ve actually borrowed, instead of the full amount.
In addition, this type of loan does reduce the amount of money that a senior is able to leave to his or her heirs. Reverse mortgages cannot be passed on to heirs and do not affect any other assets besides the home, but for homeowners who want to keep their home in the family, a reverse mortgage may not be the best option.
Myths and Facts Of Reverse Mortgages
Reverse mortgages have gotten a bad reputation from news outlets in the past, which has made some borrowers leery of reverse mortgages. Much of the bad reputation about reverse mortgages comes from practices that lenders used with these loans in the past. Prior to 2015, reverse mortgages were given to homeowners who could not keep up with basic home expenses like taxes and insurance. This led to a lot of foreclosures. Practices have changed these days, so you should get the facts about reverse mortgages before deciding whether or not this type of loan is right for you.
To get a reverse mortgage, a borrower must first pass through counseling and a strict financial assessment to determine whether or not they are a good candidate. This requirement is new as of 2015 and has helped many people successfully take out a reverse mortgage without putting their home and property at risk.
In addition, it was once commonly understood that reverse mortgages were loans of last resort, to be made only to homeowners in dire straits. This myth may extend from the same myth that reverse mortgages are bad for homeowners in general.
In reality, the best time to take out a reverse mortgage is before the homeowner is in financial difficulty. Reverse mortgages can improve quality of life and ease the burden of everyday expenses, which in turn can prevent the borrower from experiencing hard times. Waiting until the borrower is in poor financial shape may disqualify the borrower from this type of loan, or may make it more likely that the loan will fail.
Another common myth about reverse mortgages is that this type of loan is usually used to pay for vacations and fun purchases. Most seniors simply use their reverse mortgages to supplement their retirement income and enjoy a better quality of life. Often, reverse mortgages are used to cover everyday expenses like bills, food, household items, home repairs, and other normal purchases.
Finally, many people believe that reverse mortgages are only used by the very elderly. In reality, many younger seniors can enjoy the benefits of reverse mortgages. While it is true that waiting until the house has more equity can lead to a larger loan amount, it’s common practice for seniors to take out a reverse mortgage at around 62, and before actually retiring.
How Much Can You Borrow?
The amount that you can borrow will depend on many variables, including your age (or the age of the youngest borrower, if the loan is being taken out by a couple), the value of the home, the lending limit set by the lender, and the current interest rate. Factors that are of less consideration include credit history and credit score.
Older borrowers, borrowers with valuable homes, and people with more equity in their home are typically able to secure the largest loan balance. Closing costs and fees will also impact the final amount the borrower is able to get. People who are wondering how much they are likely to get from a reverse mortgage, or how large their monthly payments might be, can check out a reverse mortgage calculator to calculate likely costs and the likely amount to be expected if a loan is taken out.
The Costs Of Reverse Mortgages
One of the criticisms of reverse mortgages are the hidden costs, which can cut dramatically into the final loan amount. Knowing these costs in advance can help homeowners decide whether or not a reverse loan is right for them. The following costs are typical costs associated with reverse mortgages.
Servicing fees apply only if the loan has an annually or monthly adjusting interest rate. Servicing fees cover the general customer service associated with the processing of an adjustable rate loan. Checks, account statements and other services are included in this fee.
Loan Origination Fee
Borrowers with homes valued less than $125,000 must pay an origination fee that can be as much as $2,500. If the home is worth more than $125,000, then the origination fee may be 2% of the first $200,000, and 1% of any amount over $200,000. HECM loans have a maximum origination fee of $6,000.
Mortgage Insurance Premium (MIP)
Mortgage insurance provides a guarantee that the borrower will receive the loan even if the company managing the account goes out of business. The cost of mortgage insurance premiums varies. The upfront cost of MIP is 0.5% of the value of the home (or 2.5% of the value if more than 60% of the available funds are used). Premiums also have an annual cost of 1.25% of the outstanding balance. This is not paid annually; MIP is paid in full when the loan becomes due.
Third Party Fees
Like any mortgage, closing costs for a reverse mortgage include a variety of fees like inspections, recording fees, mortgage taxes, credit checks and an appraisal fee.
How To Get A Reverse Mortgage
Before a person can get a reverse mortgage, the borrower must be 62 years old or older; this is true both for private loans and FHA/HUD loans. Both types of loans must also be taken out on a primary residence (in other words, if the borrower has not lived in the house for a year or more, then he or she is not eligible for a reverse mortgage). In addition, because the borrower must continue to pay all taxes and mandatory insurances throughout the life of the loan, the borrower must be deemed financially capable of paying for these financial obligations. All borrowers must therefore undergo a financial assessment before he or she can take out a loan. The borrower must own the home outright or have relatively little outstanding on their mortgage. Additionally, all borrowers must undergo financial counseling before the loan is taken out. The purpose of this financial counseling is to ensure that the borrower understands the terms of the loan and what is involved in the repayment of the loan. Finally, all borrowers must pay to maintain the property and complete any necessary repairs. These qualifications may vary some depending on the type of reverse mortgage being taken out. FHA/HUD loans may be slightly different than loans obtained through a private lender.
The Counseling Requirement
Mortgage counseling is a FHA/HUD mandated requirement for any person who gets a reverse mortgage, no matter who the lender is. People who provide this type of counseling work for independent housing counseling agencies. They help borrowers understand the consequences of taking out a loan, the associated costs of taking out that loan and the ways that proceeds can be distributed. The purpose behind financial counseling is to ensure that people who take out a loan are fully informed and are making the right decision given their circumstances. Financial counseling can be done in person or over the phone, and fees may vary depending on the counselor. For people who are not sure whether or not a reverse mortgage is right for them, counselors can help them explore other options and weigh the pros and cons against each other to make the most informed decision possible. Counseling is not free, but those who can’t afford counseling can find a counselor who is willing to waive the fee. Without this counseling, borrowers cannot get this type of loan.
What Happens To The Loan After I Pass Away?
When you die, the loan becomes due. The lender will then sell the home to pay back the mortgage. Any amount left over after the loan is paid will then be passed on to your heirs or will go to your estate. The homeowner cannot, however, owe any more than the value of the home when it is sold, so even if the loan is larger than the value of the home, there are no negative consequences for the borrower or his or her heirs.
Considering A Reverse Mortgage If Your Spouse Is Under The Age of 62
A borrower must be 62 or older to get a reverse mortgage. In the past, if a couple wanted to get a reverse mortgage and one of them was younger than 62 years old, the older of the two would get the loan and the younger of the two would be left off of the mortgage. When the older spouse died, the younger spouse would be responsible for paying off the mortgage or would be faced with losing the house. Modern regulations allow a younger spouse to be on the contract without being listed as a borrower. When the borrower dies, the contract enters a deferral period that enables the younger spouse to keep the house. However, the age of the younger spouse is taken into consideration when the contract is written, which results in a lower loan amount.
Deciding Whether Or Not A Reverse Mortgage Is Right For You
Reverse mortgages give homeowners options that help them pay off bills, live more comfortably and enjoy retirement. For the right homeowner, a reverse mortgage is a smart way to enjoy the senior years. Reverse mortgages are best used as a means to supplement retirement income and are not intended to help homeowners who are in financial dire straits and who have no other choice. Homeowners who can’t decide decide whether or not a private reverse mortgage or FHA/HUD-backed HECM program loan is right for them can speak with a financial counselor to discuss options. A person who understands the financial ramifications is more likely to make a well-informed decision that can lead to financial stability.