what is a reverse mortage?
Similar to a traditional mortgage, a reverse mort loan utilizes a homeowner's home as collateral to borrow money. The title to the home stays in the owner's name, as is the case with a standard mortgage. However, unlike a traditional mortgage, reverse mortgage borrowers are not required to make monthly payments. Instead, the loan is repaid when the borrower no longer lives in the home. Every month, interest and fees are added to the loan balance, causing it to grow. To comply with the loan terms, reverse mortgage borrowers must pay property taxes and homeowners insurance, maintain the property as their primary residence, and keep the home in good condition.
Over time, the amount owed to the lender increases with a reverse mortgage loan, rather than decreasing. This is due to the addition of interest and fees to the loan balance each month. As the loan balance grows, the homeowner's equity in the home decreases.
It is essential to note that a reverse mortgage loan is not a gift, but a loan that incurs interest and fees. Borrowed funds, as well as interest and fees, accumulate each month, resulting in a growing loan balance. Ultimately, the homeowner or their heirs will be responsible for repaying the loan, usually by selling the home.
How does reverse mortage work
A reverse mortage is a loan that allows homeowners who are at least 62 years old to borrow money using their home equity as collateral. It is called a "reverse" mortgage because instead of making payments to the lender like with a traditional mortgage, the lender makes payments to the borrower. The loan is repaid when the borrower no longer lives in the home or dies, and the home is sold.
When a homeowner takes out a reverse mortgage loan, they can receive the money in a lump sum, as a line of credit, or in monthly payments. The amount they can borrow depends on several factors, such as the age of the borrower, the value of the home, and the current interest rates.
With a reverse mortgage, the title to the home remains in the borrower's name, and they are still responsible for property taxes, homeowners insurance, and maintaining the property. Interest and fees are added to the loan balance each month, which can cause the balance to grow over time. The loan is typically repaid when the borrower dies or sells the home, and any remaining equity in the home goes to the borrower or their heirs.
It's important to note that a reverse mortgage is a loan and not a gift. Borrowed funds, as well as interest and fees, accumulate each month, resulting in a growing loan balance. It's also essential to carefully consider the costs and fees associated with a reverse mortgage and to understand the potential impact on the borrower's financial situation and their heirs' inheritance.
Types of Reverse Mortages
There are three main types of reverse mortages:
- Home Equity Conversion Mortgage (HECM): This is the most common type of reverse mortgage and is insured by the Federal Housing Administration (FHA). It allows homeowners who are at least 62 years old to borrow against the equity in their home. HECMs have limits on how much homeowners can borrow, and the amount is based on factors such as the value of the home, the age of the borrower, and the interest rate.
- Proprietary Reverse Mortgage: This type of reverse mortgage is not insured by the FHA and is offered by private lenders. It is generally available for homeowners with higher-value homes and can allow for higher borrowing amounts than HECMs.
- Single-Purpose Reverse Mortgage: This type of reverse mortgage is typically offered by state or local government agencies and nonprofit organizations. It is used for a specific purpose, such as home repairs or property taxes.
When considering a reverse mortgag, there are six options for how to receive the proceeds:
- Lump sum: You can get all the money at once when the loan closes. This option has a fixed interest rate, unlike the other five, which have adjustable interest rates.
- Equal monthly payments (annuity): The lender will make regular payments to you for as long as at least one borrower lives in the home as their primary residence. This is also known as a tenure plan.
- Term payments: You can receive equal monthly payments for a set period of your choosing, such as 10 years.
- Line of credit: You can access the funds as you need them, and you only pay interest on the amounts actually borrowed.
- Equal monthly payments plus a line of credit: You can receive steady monthly payments for as long as at least one borrower lives in the home as their primary residence. If you need more money, you can access the line of credit.
- Term payments plus a line of credit: You can receive equal monthly payments for a set period of your choosing, such as 10 years. If you need more money during or after that term, you can access the line of credit.
It's important to note that to qualify for a reverse mortgage, you typically need at least 50% equity in your home based on its current value, not what you paid for it. Additionally, it is possible to use a reverse mortgage called a "HECM for purchase" to buy a different home than the one in which you currently live.
Who Is a Reverse Mortgag Right For?
Although a reverse mortgag shares similarities with a home equity loan or home equity line of credit (HELOC), there are some key differences. Like these loans, a reverse mortgage allows you to access a lump sum or line of credit based on how much equity you have in your home and its current market value. However, unlike these other loans, a reverse mortgage does not require you to have a steady income or good credit to qualify. Additionally, while living in your home as your primary residence, you will not need to make any loan payments.
A reverse mortgage can be an attractive option for seniors who:
- Do not want the responsibility of making a monthly loan payment.
- Cannot afford a monthly loan payment.
- Are unable to qualify for a home equity loan or cash-out refinance due to limited cash flow or poor credit.
Although there are other types of loans available, such as unsecured personal loans, they often require monthly repayments and do not allow you to tap into your home equity without selling your home.
What Is Required for a Reverse Mortagage?
To be eligible for a reverse mortagage, you must meet certain requirements:
- Age: You must be at least 62 years old or older. If you have a co-borrower, they must also meet this requirement.
- Homeownership: You must own your home outright or have a low mortgage balance that can be paid off with the proceeds from the reverse mortgage.
- Property Type: The home must be your primary residence, a single-family home, a two-to-four unit property that you own and occupy, a townhouse, or an FHA-approved condominium or manufactured home.
- Financial Assessment: Lenders will assess your credit history, income, and expenses to determine if you can afford to pay property taxes, homeowners insurance, and other property charges. If the lender determines you may not be able to afford these costs, they may require you to set aside part of the loan proceeds to pay for them.
- Counseling: Before you can apply for a reverse mortgage, you must complete a counseling session with a HUD-approved counselor. The counselor will review the loan terms, explain your options, and answer any questions you may have.
If you meet these requirements, you may be eligible for a reverse mortgage. Keep in mind that the loan amount you can receive will depend on your age, the value of your home, and current interest rates.
What Are the Costs of a Reverse Morgage?
In October 2017, the Department of Housing and Urban Development (HUD) made changes to the insurance premiums for reverse mortgages. These premiums are designed to protect lenders if the loan balance grows larger than the value of the home, as they cannot require homeowners or their heirs to pay the difference.
One of the changes was an increase in the up-front premium for most borrowers, from 0.5% to 2.0%, and a decrease for the remaining one in four borrowers, from 2.5% to 2.0%. Previously, the up-front premium was based on the amount borrowers took out in the first year, with those borrowing more paying higher rates. Now, all borrowers pay a flat rate of 2.0% based on the home’s value, which means $2,000 for every $100,000 of appraised value. The maximum fee is $6,000, even for homes worth more.
All borrowers are also required to pay an annual mortgage insurance premium (MIP) of 0.5% (previously 1.25%) of the amount borrowed. This change reduces the borrower's annual costs by $750 for every $100,000 borrowed and offsets the higher up-front premium. It also slows down the growth of the borrower’s debt, which preserves more of the homeowner's equity, provides a source of funds in the future, and increases the likelihood of leaving the home to heirs.
Reverse Mortgage Interest Rates
The lump sum (single disbursement) reverse morgage is the only option that comes with a fixed interest rate, meaning you receive all the proceeds at once and are charged interest at a fixed rate. The other five options come with adjustable interest rates, which is more suitable for borrowing money over an extended period since interest rates continually change. The variable-rate reverse mortgages are connected to a benchmark index, such as the Constant Maturity Treasury (CMT) index.
In addition to the base rate, the lender includes a margin ranging from one to three percentage points. Suppose the index rate is 2.5%, and the lender's margin is 2%. In that case, the interest rate on your reverse mortgage will be 4.5%. Interest accrues over the life of the reverse mortgage, and your credit score does not impact your reverse mortgage rate or eligibility. However, the lender may require a Life Expectancy Set Aside account for your property taxes, homeowners insurance, and other mandatory property charges, depending on your credit score.
How Much Can You Borrow with a Reverse Mort?
The amount of money you can receive from a reverse mortgage varies depending on your lender and payment plan. For an HECM, the loan amount is determined by the youngest borrower’s age, the loan’s interest rate, and the lesser of your home’s appraised value or the FHA’s maximum claim amount, which is currently $970,800 as of Jan. 1, 2022.
It's important to note that you cannot borrow 100% of your home's value or anything close to it. A portion of your home equity must be used to pay the loan's expenses, such as mortgage premiums and interest. Here are some other things to consider regarding how much you can borrow:
- The loan proceeds are based on the age of the youngest borrower, or if the borrower is married, the younger spouse, even if they are not a borrower. The older the youngest borrower is, the more you can borrow.
- The lower the mortgage rate, the more you can borrow.
- The higher your property's appraised value, the more you can borrow.
- A strong financial assessment for the reverse mortgage increases the proceeds you'll receive, as the lender won't withhold a portion of them to pay property taxes and homeowners insurance.
The initial principal limit determines how much you can borrow. 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. However, this change helps borrowers preserve more of their equity.
The government lowered the limit for the same reason it changed insurance premiums: to address the mortgage insurance fund's nearly doubled deficit from the previous fiscal year. This fund pays lenders and protects taxpayers from reverse mortgage losses.
To complicate matters, if you opt for a lump sum or line of credit, you cannot borrow all of your initial principal limits in the first year. Instead, you can borrow up to 60%, or more if you're using the funds to pay off your forward mortgage. With a lump sum, the upfront amount is all you'll ever receive. If you select a line of credit, your credit line will increase over time, but only if you have unused funds in your line.
Avoiding Reverse Mort Scams
Scammers often target vulnerable seniors who are seeking financial relief with reverse mortgages. These unscrupulous individuals may include home improvement contractors and vendors who promise to help seniors secure reverse mortgages to pay for home improvements, but then steal the homeowner's money without delivering on their promises.
In addition to vendors and contractors, seniors may also fall prey to scams perpetrated by relatives, caregivers, and financial advisors. Some may use a power of attorney to secure a reverse mortgage on the senior's home, only to steal the proceeds for themselves. Others may convince the senior to purchase a financial product, such as an annuity or whole life insurance policy, that they can only afford by obtaining a reverse mortgage. These transactions are often only in the best interest of the financial advisor, relative, or caregiver, and can have devastating consequences for the senior.
Unfortunately, these are just a few examples of the many scams that exist in the world of reverse mortgages, and homeowners must remain vigilant to avoid becoming victims of financial exploitation.
How to Avoid Reverse Mortgage Foreclosure
One of the potential risks associated with a reverse mort is the threat of foreclosure. Despite the fact that the borrower is not responsible for making regular mortgage payments and cannot fall behind on them, certain conditions must be met to maintain the reverse mortgage. Failure to meet these conditions gives the lender the right to foreclose on the property.
As a reverse mortgage borrower, you must reside in and maintain the property. If the property deteriorates, its value will decrease when it is sold, and the lender will not be able to recover the full amount that was borrowed.
In addition, reverse mortgage borrowers must keep up with property taxes and homeowners insurance. These requirements are imposed by the lender to safeguard its interest in the property. Failure to pay property taxes can result in the property being seized by the local tax authority. If the borrower does not have homeowners insurance and the property is damaged in a fire, for instance, the collateral that the lender holds is also damaged.
Is a Reverse Mortgage Expensive?
Yes, a reverse mort can be expensive due to various costs involved. These costs can include origination fees, mortgage insurance premiums, closing costs, appraisal fees, and servicing fees. In addition, the interest rates on reverse mortgages tend to be higher than traditional mortgages. These costs can add up, making a reverse mortgage a costly option for homeowners. It's important for homeowners to fully understand the costs associated with a reverse mortgage before deciding whether it's the right option for them. Use the reverse mortage calculator to help determine the balance of a reverse mortgage.
When Do You Have to Repay a Reverse Morgage?
A reverse mortgage is a loan that allows homeowners to convert a portion of their home equity into cash. While the borrower doesn't have to make any payments on the loan while they're living in the home, the loan does have to be repaid when certain events occur.
The borrower is required to repay the reverse mortgage when they move out of the home, sell the home, or pass away. In the event of the borrower's death, their heirs will have to repay the loan or sell the home to pay off the outstanding balance.
If the home is sold for more than the outstanding balance of the reverse mortgage, the borrower or their heirs will receive the difference. However, if the home is sold for less than the outstanding balance of the reverse mortgage, the borrower or their heirs won't be responsible for paying the difference. The lender will have to absorb the loss.
It's important for borrowers to understand the repayment terms of a reverse mortgage and plan accordingly to ensure they have the means to repay the loan when the time comes.
Can You Owe More Than the Home Is Worth with a Reverse Mortgage?
It is possible to owe more than the home is worth with a reverse morgage. This is because the loan balance increases over time as interest and fees are added to the initial amount borrowed, while the value of the home may stay the same or decrease. If the loan balance exceeds the value of the home when it is sold, the borrower or their heirs will not receive any proceeds from the sale, and the difference will be covered by the mortgage insurance or the borrower's other assets. However, the amount owed on a reverse mortgage can never exceed the home's value at the time of repayment, thanks to the non-recourse feature of the loan. This means that the borrower or their heirs are not personally liable for any shortfall in the event of a sale, and the lender cannot pursue them or their estate for any amount owed beyond the home's value.
Can You Refinance a Reverse Mortgage?
Yes, it is possible to refinance a reverse morgage. Refinancing a reverse mortgage involves obtaining a new reverse mortgage to replace the existing one. The primary reasons for refinancing a reverse mortgage include obtaining a lower interest rate, increasing the available line of credit, or adding a non-borrowing spouse to the loan.
When considering refinancing, it's important to carefully review the costs associated with the new loan, including origination fees, closing costs, and mortgage insurance premiums. In addition, it's important to consider the impact of any changes to the loan terms, such as the interest rate and payment plan, on the overall cost of the loan.
It's important to work with a reputable reverse mortgage lender to determine whether refinancing is the right option for your individual financial situation. The lender can help you evaluate the costs and benefits of refinancing and guide you through the application process.
The Bottom Line
For senior homeowners, a reverse mortgage can be a useful financial tool if they fully understand how the loan works and what tradeoffs it entails. Ideally, those interested in obtaining a reverse mortgage should take the time to thoroughly educate themselves about the loan, so they won't fall victim to unscrupulous lenders or predatory scammers, and they can make a sound decision even if they receive poor-quality counseling.
Reverse mortgages can be complex, and borrowers should educate themselves to ensure they make the best use of their home equity. In addition, they should comparison shop for the best reverse mort lenders and avoid going with the first lender who approaches them. Rates and fees can vary significantly among lenders, and the federal government does not regulate reverse mortgage rates.