1) What Is a Reverse Mortgage?
A reverse mortgage is a loan that allows qualified homeowners who are age 62 or older to take part of their home’s equity as cash, either as a line of credit, or monthly or lump sum payment, or combo of a credit line and payments. But, unlike a standard mortgage loan, it requires no repayment until the borrower no longer occupies the residence. Borrowers with reverse mortgages are still required to pay the real estate taxes, homeowners insurance, flood insurance, and association dues.
With careful planning, reverse mortgages can be used as a way to supplement other retirement income. Reverse mortgages also can be used to purchase a home if you are able to come up with the difference in cash from the proceeds of the reverse mortgage loan and the purchase price of the property.
2) Who offers Reverse Mortgage Loans?
The major source of reverse mortgages has been the one insured by the Federal Housing Administration (FHA) called the Home Equity Conversion Mortgage program (HECM). An HECM is the only reverse mortgage that’s insured by the federal government, and HECMs are only available through an FHA-approved lender.
Non-HECM reverse mortgages are available from other lenders, banks, or credit unions. The main benefit of using a non-HECM lender is that they offer reverse mortgage loans in amounts higher than the limit set by HECM lenders. However, they can be significantly more expensive than HECM loans and they are not insured by the federal government.
3) Reverse Mortgage Eligibility
Homeowners who are over the age of 62 and have either paid off their home loan or have a very small balance — which must be paid off upon closing of the reverse mortgage – are eligible. That’s why reverse mortgages are almost always done after retirement to supplement the borrower’s post-retirement income. Additionally, the property must be HUD-approved and you must live in the home. Eligible property types include single-family homes, 1-4 unit properties, some condos and manufactured homes.
4) How Does a Reverse Mortgage Work?
Reverse mortgages work similar to how annuities work — they are based primarily on life expectancy of the borrowers. The maximum amount that can be received from a reverse mortgage loan depends on the following factors:
- Age of the youngest borrower
- Lesser of the value of the property (home equity) or up to the maximum county limit of $679,650
- Current interest rate
The older the borrower, the more home equity available. Also, the lower the interest rate will also increase the amount of funds that a borrower may receive from the loan. Once the amount has been established based on the above factors, you must select your method of payment from the following options:
- Lump sum cash payout – Single proceeds payment at the time of closing
- Line of credit – Funds are in a line of credit that may be drawn when needed
- Term – Fixed number of payments for a fixed period of time
- Tenure – Equal monthly payments that continue if at least one borrower continues to occupy the property
- Modified term – Combination of a line of credit and a fixed number of payments for a fixed term
- Modified tenure – Combination of a line of credit and monthly payments for as long as at least one borrower continues to occupy the residence
While there are many payment options, the Consumer Finance Protection urges borrowers to consider the monthly payment or line of credit options over the lump-sum cash payout. Line of credit options provide more long-term security for retirement. Typically, non-HECM reverse mortgages offer fewer income options.
When the property is sold or no longer used as a primary residence, the cash you received in a line of credit or payment, interest, and other HECM finance charges must be repaid. All proceeds beyond the amount owed belong to your spouse or estate. This means any remaining equity can be transferred to heirs. No debt is passed along to the estate or heirs.
5) What are the Costs Associated with a Reverse Mortgage?
The cost of a reverse mortgage loan will vary by lender, and the actual costs is largely dependent on the income option you select. But the main costs include:
- Origination fee: This is the fee that you will pay to the lender for originating the loan for your property. This amount will vary by lender, but they are capped by the FHA. For homes valued at $125,000 or less, the origination fee is capped at $2,500. For homes valued at more than $125,000, the cap is 2% of the value of the first $200,000 and 1% on the value above $200,000, for a maximum of $6,000.
- Third-party closing costs: These fees will also vary by lender and include items like appraisal fees and credit checks for both borrowers.
- Mortgage insurance: Reverse mortgages require you to pay a mortgage insurance premium (MIP) at closing, as well as a monthly MIP for the life of the loan at 1.25% of the balance of your loan.
- Interest: Interest rates for reverse mortgage loans are almost always adjustable rates, meaning the interest rate will change monthly or annually, depending on the type you choose.
- Servicing fee: This is the fee for the cost of servicing your loan. Servicing fees are less common today than they have been in the past.
When looking for a lender for your reverse mortgage, be sure to compare these costs to understand which loan makes financial sense for you. You can find these numbers by looking at the total annual loan cost that you will receive from each lender.
6) What Are the Advantages and the Disadvantages of the Program?
- Borrowers are able to stay in their home after retirement for as long as they are physically able.
- The funds from a reverse mortgage loan can be used to help supplement other retirement incomes (Social Security, pensions, savings, etc.).
- No debt can be passed along to heirs or estate.
- Easier to qualify for than a standard mortgage loan. Your credit report will need to be run, but your specific credit score number is not used to qualify for a reverse mortgage.
- Borrowers could possibly use up a large portion of the equity in their home and have less inheritance to pass on to their heirs.
- Closing costs and fees for a reverse mortgage are substantially higher than conventional mortgages.
- Interest rates for reverse mortgages are typically higher than interest rates of conventional mortgages.
- The real estate taxes, homeowners insurance, and maintenance on the home are still the responsibility of the borrower to continue to pay. You could lose your home if you don’t.
Tapping into your home equity in your retirement years is a big decision and can be risky. If you’re age 62 or older and considering a reverse mortgage, be sure to talk to your financial planner to see if this type of loan would help you supplement your retirement income. And be sure to get quotes from multiple lenders to find the loan that makes financial sense for you during your retirement. Learn more about Home Equity Conversion Mortgages (HECM) for Seniors here.