What Is Reverse Mortgage?
A reverse mortgage is, in a word, a loan. A homeowner who is at least 62 years old and has substantial home equity can borrow against the value of their residence and accept money as a fixed monthly payment, lump sum or line of credit. In contrast to a conventional mortgage, a reverse mortgage does not demand the homeowner to make loan payments.
Instead, the entire loan balance, subject to a cap, becomes due and payable upon the borrower's death, permanent move out, or sale of the property. The transaction must be structured so that the loan amount does not surpass the home's value, per federal regulations.
1. Even if it does, due to a decline in the home's market value or
2. if the borrower lives longer than anticipated, the borrower or borrower's estate will not be required to pay the difference to the lender because of the program's mortgage insurance.
A reverse mortgage is a type of home loan for seniors 62 and older. Reverse mortgage loans allow homeowners to change their home equity into cash income with no monthly mortgage payments.
Before borrowing, make sure you understand how reverse mortgages operate and what they mean for you and your family.
Cash in Equity
Reverse mortgages can provide much-needed cash to senior citizens whose wealth is primarily tied to their home equity: the market value of their home minus any outstanding home loans. However, these loans can be expensive, complicated, and susceptible to fraud.
According to the National Reverse Mortgage Lenders Association, 62-year-old and older homeowners held $10.19 trillion in home equity in the third quarter of 2021 (Q3). The number represents an all-time high since measurement began in 2000, highlighting the importance of home equity as a source of wealth for retirees.
The only way to utilize home equity is to sell and downsize or to borrow against it. This is where reverse mortgages come into play, particularly for retirees with limited incomes and few other assets, as well as for retirees who wish to diversify their income and sequence risk, reduce investment risk, and longevity risk.
How Reverse Mortgages Works
With a reverse mortgage, the lender makes payments to the homeowner rather than the homeowner making payments to the lender. The homeowner chooses how to receive these payments and only pays interest on the proceeds received. The interest is added to the loan balance so the homeowner does not have to pay it up front. The homeowner also retains the home's title. Over the life of the loan, the homeowner's debt and equity decrease.
Similar to a conventional mortgage, the home serves as collateral for a reverse mortgage. When the homeowner moves or passes away, the proceeds from the sale of the home are used to repay the reverse mortgage's principal, interest, mortgage insurance, and fees to the lender. The remainder of the sale proceeds go to the homeowner (if still alive) or the homeowner's estate (if the homeowner has died). In some instances, the heirs may choose to pay off the mortgage in order to retain ownership of the property.
The proceeds from reverse mortgages are not taxable. The Internal Revenue Service (IRS) considers these funds to be a loan advance, even though the homeowner may view them as income.
Types of Reverse Mortgages
Reverse mortgage is of three types. Home equity conversion mortgages are the most prevalent (HECM). This article will focus on the most likely type of reverse mortgage, which is the HECM. This type of mortgage, also known as a Federal Housing Administration (FHA) reverse mortgage, is only available from FHA-approved lenders.
However, if your home is worth more, you can consider a jumbo reverse mortgage, also known as a proprietary reverse mortgage.
When you obtain a reverse mortgage, you have six options for receiving the proceeds:
1. Lump sum:
When your loan closes, you receive all of the proceeds at once. This is the only option with a fixed rate of interest.
The following has 5 variable interest rates.
2. Equal monthly payments (annuity):
The lender will make consistent payments to the borrower for as long as at least one borrower resides in the home as a primary residence. Alternatively known as a tenure plan.
3. Term payments:
The lender provides the borrower with equal monthly payments for an agreed-upon period, such as 10 years.
4. Line of credit:
The homeowner has the ability to borrow funds as needed. The homeowner only pays interest on the actual credit line amounts borrowed.
5. Equal monthly payments plus a line of credit:
6. Term payments plus a line of credit:
The lender provides the borrower with equal monthly payments for a set period, such as 10 years, that the borrower chooses. If the borrower requires additional funds during or after the term, they can access the credit line.
It is also possible to use a reverse mortgage known as a "HECM for purchase" to purchase a home other than your current residence.
To qualify for a reverse mortgage, you will typically need at least 50 percent equity based on the current value of your home, not what you paid for it
Would Obtaining a Reverse Mortgage Benefit You?
Reverse mortgages may sound similar to home equity loans and home equity lines of credit (HELOC). In fact, similar to these loans, a reverse mortgage can provide you with a lump sum or a line of credit that you can access as needed, based on how much of your mortgage you've paid off and the market value of your home. However, unlike a home equity loan or a HELOC, you are not required to have a steady income or good credit to qualify, and you will not be required to make loan payments while living in the home as your primary residence.
In situations such as these, a reverse mortgage is the only way for seniors to access home equity without selling the property:
• desire to avoid the obligation of making a monthly loan payment
• cannot afford a loan payment each month
• cannot qualify for a home equity loan or refinance due to insufficient income or poor credit
What Is Required for a Reverse Mortgage?
Property Type
If you own a single-family home, condominium, townhouse, or manufactured home constructed on or after June 15, 1976, you may qualify for a reverse mortgage. Reverse mortgage is ineligible for Cooperative housing owners under FHA guidelines because they do not technically own the property they reside on; rather, they own shares in a corporation. In New York, where co-ops are prevalent, state law prohibits reverse mortgages on co-ops and only permits them on single- to four-family homes and condominiums.
Age, Ownership, and Fees
Although reverse mortgages do not have income or credit score requirements, there are still eligibility requirements. You must be at least 62 years old and either own your home outright or have a significant amount of equity (at least 50 percent). Borrowers must pay an origination fee, an upfront mortgage insurance premium, other standard closing costs, ongoing mortgage insurance premiums (MIPs), (sometimes) loan servicing fees, and interest. The federal government restricts the interest rates that lenders can charge for many of these items.
Counseling
All prospective reverse mortgage borrowers are required to complete a HUD-approved counseling session. This counseling session, which typically costs around $125, should last at least 90 minutes and cover the advantages and disadvantages of obtaining a reverse mortgage in light of your particular financial and personal circumstances. It should describe how a reverse mortgage may impact eligibility for Medicaid and Supplemental Security Income (SSI). The counselor should also discuss the various methods for receiving the proceeds.
Collateral Security
In accordance with reverse mortgage regulations, you are responsible for paying property taxes and homeowners insurance (and homeowners association fees, if applicable) and maintaining the home in good condition. And if you stop living in the home for more than a year — even if it's for medical reasons and you're in a long-term care facility — you will be required to repay the loan, which is typically accomplished by selling the home.
In addition to the possibility of senior-targeted fraud, reverse mortgages pose some legitimate risks. Despite recent reforms, it is still possible for a widow or widower to lose their home upon the death of their spouse.
What Are the Costs of a Reverse Mortgage?
In October 2017, HUD adjusted insurance premiums for reverse mortgages. Since lenders cannot ask homeowners or their heirs to pay if the loan balance exceeds the home's value, the insurance premiums provide a pool of funds from which lenders can draw to avoid financial loss.
For three out of four borrowers, the up-front premium increased from 0.5% to 2.0%, while the up-front premium decreased from 2.5% to 2.0% for the other one out of four borrowers. Historically, the upfront premium was proportional to the amount of money a borrower took out in the first year, with homeowners who took out the most money to pay off an existing mortgage paying the highest rate. Currently, all borrowers pay a rate of 2.0%. The upfront premium is calculated based on the home's value, so you pay $2,000 for each $100,000 in appraised value. This equates to $6,000 on a $300,000 home, for instance. In fact, the fee is capped at $6,000, regardless of the value of your home.
Additionally, all borrowers must pay annual MIPs of 0.5% (previously 1.25%) of the loan balance. This modification saves borrowers $750 per year for every $100,000 borrowed, which helps to offset the increased upfront premium. It also means that the borrower's debt grows more slowly, preserving more of the homeowner's equity over time, providing a source of funds later in life, and boosting the likelihood that the home can be passed on to heirs.
Reverse Mortgage Rates of Interest
Only the lump sum (single disbursement) reverse mortgage is a fixed interest rate, as you receive the entire loan amount at closing. The other five options have variable interest rates, which makes sense given that you are borrowing money over an extended period of time and not all at once, and that interest rates are constantly fluctuating. The benchmark index for variable-rate reverse mortgages is frequently the Constant Maturity Treasury (CMT) index.
The lender adds a margin between one and three percentage points to one of the base rates. Consequently, if the index rate is 2.5% and the lender's margin is 2%, the interest rate on your reverse mortgage will be 4.5%. As of January 2022, the margins of lenders ranged between 1.5% and 2.5%. Interest accrues over the life of the reverse mortgage, and your credit score has no bearing on your rate or ability to qualify (though it does affect whether the lender may require a Life Expectancy Set Aside account for your property taxes, homeowners insurance, and other required property charges).
How Much Money Can You Borrow Using a Reverse Mortgage?
The amount you receive from a reverse mortgage is depending upon the lender and the terms of your payment schedule. The maximum amount you can borrow with a HECM is determined by the age of the youngest borrower, the loan's interest rate, and the lesser of your home's appraised value or the FHA's maximum claim amount, which is $970,800 as of January 1, 2022.
However, you cannot borrow the full value of your home or even close to it. You must use a portion of your home equity to pay the loan's expenses, such as mortgage premiums and interest.
Here are some additional considerations regarding how much you can borrow:
• The loan proceeds are determined by the age of the youngest borrower or, if the borrower is married, by the age of the younger spouse, even if the younger spouse is not a borrower. The loan proceeds increase in proportion to the age of the youngest borrower.
• The lower the mortgage interest rate, the greater the loan amount.
•The higher the appraised value of your property, the more you can borrow.
•A strong reverse mortgage financial evaluation increases the proceeds you receive because the lender will not retain a portion of them to pay your property taxes and homeowners insurance.
Initial principal limit determines the maximum amount of money that can be borrowed. In October 2017, the federal government reduced the initial principal limit, making it more difficult for homeowners, particularly younger ones, to qualify for a reverse mortgage. On the plus side, the modification allows borrowers to keep more of their equity.
The government lowered the limit for the same reason it altered insurance premiums: the mortgage insurance fund's deficit nearly doubled in the previous fiscal year. This fund compensates lenders and safeguards taxpayers against reverse mortgage losses.
When you choose a lump sum or a line of credit, you cannot borrow the maximum amount of your initial principal limit in the first year. You can instead borrow up to 60%, or more if the funds are being used to pay off your forward mortgage. If you choose a lump sum, the amount you receive up front is the only amount you will ever receive. If you choose the line of credit, your credit line will increase over time, but only if there are funds in the line that remain unused.
Avoiding Reverse Mortgage Scams
With a product as potentially lucrative as a reverse mortgage and a vulnerable borrower population that may have cognitive impairments or be desperate for financial salvation, scams abound. Unscrupulous vendors and home improvement contractors have targeted seniors in order to assist them in obtaining reverse mortgages to pay for home improvements, or, in other words, to make money off of them. The vendor or contractor may or may not deliver the quality work that was promised; they may simply steal the homeowner's money.
Relatives, caregivers, and financial advisors have also exploited seniors by using a power of attorney to reverse mortgage the home and then stealing the proceeds, or by convincing them to purchase a financial product, such as an annuity or whole life insurance policy, that the senior can only afford by obtaining a reverse mortgage. This transaction is probably only in the ostensible best interests of the financial advisor, relative, or caregiver. These are merely a few of the reverse mortgage scams that can take advantage of unsuspecting homeowners.
Do This to Avoid Reverse Mortgage Foreclosure
The possibility of foreclosure is an additional risk associated with reverse mortgages. Even though the borrower is not required to make mortgage payments and therefore cannot become delinquent, a reverse mortgage requires the borrower to satisfy certain conditions. If these conditions are not met, the lender may foreclose.
As a reverse mortgage borrower, you must reside in and maintain the property. If the home falls into disrepair, the lender will not be able to recoup the full amount it has loaned to the borrower when it comes time to sell.
Additionally borrowers of reverse mortgage is to maintain current property tax and homeowner's insurance payments. Again, the lender imposes these conditions to safeguard its interest in the property. If you do not pay your property taxes, the local tax authority has the right to seize your home. If you lack homeowner's insurance and a house fire occurs, the lender's collateral is damaged.
Average monthly interest rates for home equity conversion loans (HECMs). Individual rates will vary by lender and payout type.
Whether Reverse Mortgage is Costly?
Home equity conversion mortgages (HECMs), the most prevalent type of reverse mortgage, incur a variety of upfront and ongoing fees. Origination fees, closing costs, mortgage insurance premiums, and interest accrued on the loan balance are the most significant of these costs.
When Must You Repay a Reverse Mortgage?
The lender will require repayment of the reverse mortgage if the borrower commits any of the following acts:
Sells the home, resides outside the home for more than a year, dies, fails to maintain the property and stops paying the homeowners insurance premiums / property taxes
There are exceptions to these rules for eligible non-borrowing spouses who wish to remain in the home following the death of their borrowing spouse.
Can You Owe More on a Reverse Mortgage Than the Home Is Worth?
Your loan balance may exceed the value of your home, but lenders cannot pursue borrowers or their heirs if the home is underwater when the loan is due. When this occurs, the mortgage insurance premiums paid by borrowers are deposited into a fund that compensates lenders for their losses.
Is it possible to refinance a reverse mortgage?
Of course, it is possible to refinance a reverse mortgage. Due to the origination fee, upfront mortgage insurance premium, and other closing costs, refinancing a reverse mortgage should be reserved for situations in which a spouse must be added to the loan, additional equity is required, or the interest rate can be significantly lowered.
The Bottom Line
Reverse mortgages is a useful financial tool for senior homeowners who comprehend how the loans function and the associated drawbacks. Idealistically, anyone interested in obtaining a reverse mortgage will take the time to learn the ins and outs of these loans. Thus, no unscrupulous lender or predatory scammer will be able to take advantage of them, they will be able to make a sound decision even if they receive a poor-quality reverse mortgage counsellor, and there will be no unpleasant surprises associated with the loan.
Even when issued by the most reputable lenders, a reverse mortgage remains a complex product. Borrowers must take the time to educate themselves in order to utilize their home equity in the most advantageous manner. Additionally, they should not choose the first lender who solicits their business. The federal government does not set the rates for reverse mortgages, so rates and fees can vary widely between lenders.
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