What is a Reverse Mortgage?
A Reverse Mortgage is a loan that enables older homeowners to convert a portion of their home equity into cash. It may also provide a way for those with limited income to better manage their retirement finances by allowing them to use accumulated equity to cover living expenses.
As long as you live in the home, you’re not required to make monthly mortgage payments.* Instead, the lender makes monthly payments to you. That’s why it’s known as a reverse loan because with a traditional mortgage it’s the other way around, the borrower pays the lender. In this case, the borrower is not required to pay back the reverse loan until the home is sold, vacated, or the owner passes away; and the homeowner still retains ownership of the home. However, you must remain current on property taxes, hazard insurance, homeowner’s association dues, any other applicable fees, and you must be able to maintain the property.
- No FICO qualification
- No debt-to-income ratios - though borrowers must demonstrate a willingness and capacity to pay basic obligations
- Provides greater freedom in retirement - you aren’t restricted on how you can use the loan proceeds and it is non-taxable funds
- Non-recourse loan
- A reverse purchase can help a borrower retain their savings, improve their monthly cash flow, and / or finance a purchase that would normally be beyond their budget
- It can help seniors relocate to a different region or to move closer to family
- It can also help seniors move into a more affordable home that requires less maintenance, or better serves their physical needs by providing features like handrails, wider doors, or a single-story layout
- Helps borrowers age in place
Check out some common myths busted by New American Funding
Reverse Mortgage Requirements
- Borrowers must be 62 years of age or older
- Borrowers must qualify to pay taxes, insurance, or HOA if applicable
- You can own your home outright, or have a low balance on your mortgage that can be paid off at closing with proceeds from the reverse loan
- The borrower also must have financial resources to pay ongoing property fees
- Before obtaining this type of loan, all borrowers and non-borrowing spouses must receive independent counseling
Reverse Mortgage Loan Options
This type of loan is insured by the Federal Housing Administration (FHA). It is part of the Home Equity Conversion Mortgage (HECM) program. There are several types of Reverse Mortgages:
- Payment of loan proceeds – The borrower receives the loan money as a line of credit, monthly installments, a combination of both, as a lump sum, or the payment retires an existing mortgage.
- Interest Rate – The borrower chooses between a fixed interest rate and an adjustable interest rate. A fixed interest rate is only available with the lump sum payment option.
- Purchase – It allows the borrower to purchase a principal residence. It requires less upfront investment than an all-cash purchase.
- Refinance – It allows a borrower to convert one HECM loan into another HECM loan, which is usually done to lock in a lower interest rate or to borrow more cash if the home has increased in value.
While you have your choice of payment options, the Consumer Finance Protection Bureau strongly recommends considering monthly payments or lines of credit as opposed to the lump-sum payout option. Lines of credit offer more long-term security during retirement.
There are other reverse mortgages not tied to HECM offered by other lenders, banks, or credit unions. Such reverse mortgages are offered in higher amounts than the limits imposed by HECM lenders. On the other hand, they can be much more expensive than HECM loans and aren’t insured by the federal government.
Costs Involved with Reverse Mortgages
As mentioned, you will need to stay up to date when it comes to your property taxes, hazard insurance, homeowner’s association dues, and any other applicable fees.
While the cost of a reverse mortgage can vary depending on the lender and your particular income option, other costs can include the following:
Origination fee—the fee paid to the lender for originating your loan. This can vary according to the lender but are limited by the FHA. Homes valued at $125,000 or more, the origination fee can be no more than $2,500. Homes worth more than this are capped at 2% of the value of the first $200,000 and 1% on the value over $200,000 for a maximum of $6,000.
Interest—when it comes to reverse mortgages, interest rates typically are adjustable, thus they will change every month or year depending on the type you choose.
3rd party closing costs—these fees can vary by lender and include appraisal fees and credit checks for both borrowers.
Servicing fee—the fee associated with the cost of servicing your loan, though they are less common than in the past.
Mortgage insurance—you must pay a mortgage insurance premium at closing along with a monthly premium for the life of the loan, which is 1.25% of the loan balance.
It’s a good idea to compare these related costs when looking into a reverse mortgage to determine the type of loan that is best for you.
Reverse Mortgage: What to Watch Out For
While reverse mortgages are extremely beneficial to many homeowners, you need to be aware of potential drawbacks.
- Closing costs and fees tend to be higher with a reverse mortgage than they are for conventional ones.
- Reverse mortgage interest rates are often higher than those for conventional loans.
- It is possible that borrowers can use up much of their home’s equity and therefore have less of an inheritance to pass on.
- You could risk losing your home if you fail to keep up on real estate taxes, homeowners insurance, and home maintenance.
For more information on how reverse mortgages work, take a look at our recent blog, “How a Reverse Mortgage Works.”
Talk to a financial planner if you are at least 62 years of age and are considering a reverse mortgage. Consult with New American Funding and make the best decision with our team behind you.
*Borrower must pay required taxes, insurance, or HOA if applicable.
How Much Can I Get in a Reverse Mortgage?
The amount a borrower can obtain depends on a few factors, including:
- The home's appraisal value
- The amount of equity in the home
- Borrower's age
- Interest rate
Additionally, the FHA's lending loan limits may determine what the borrower's reverse mortgage can pay, even if their home's appraisal is worth more.
Will a Reverse Mortgage Affect My Benefits?
While a reverse mortgage will not affect a borrower's Social Security or Medicare, it might affect their Medicaid or Supplemental Security Income (SSI). Unlike Social Security and Medicare, which are non-means-tested programs, needs-based programs like SSI or Medicaid are directly related to an individual's income and assets.
Can a Reverse Mortgage Be Foreclosed?
Yes, a reverse mortgage can be foreclosed after a trigger event, also known as a maturity event, occurs. These events can include things like the owners of the reverse mortgage pass away or sale of the property.
When Can I Refinance a Reverse Mortgage?
The US Department of Housing and Urban Development (HUD) states that borrowers can refinance their reverse mortgage after 18 months. It is possible to refinance a reverse mortgage into another reverse mortgage with better terms or into a conventional loan.
What Happens to a Reverse Mortgage When the Owner Passes Away?
If there are two co-borrowers, the surviving co-borrower can continue to live in the home and receive the reverse mortgage payments until they too pass away or move out of the home.
However, depending on the terms of the reverse mortgage, the surviving spouse of the sole borrower may have to repay the loan soon after the borrower's passing.
Additionally, if both borrowers were to pass, a few options exit for their heirs, including:
- Selling the home to pay the remaining balance of the reverse mortgage.
- Taking out a new mortgage in the event they want to keep the home.