What is a reverse mortgage? The quick and simple answer to this question is that a reverse mortgage is basically a loan. If you are under 62 years old or older and have home equity, you can get a loan against the value of your home or property and get money either as a lump sum, line of credit or fixed monthly payments. So differently from a forward mortgage, where the home owner needs to pay monthly payments, a reverse mortgage means that the home owner will not pay any loan payments.
The whole idea of a reverse mortgage is that the home owner can get a sum of money from the lender, in return for equity in his home. The way is works is that the loan balance needs to be repaid when the homeowner dies or sells the home. There are obviously federal regulations and conditions & structures to each loan, usually it is structured in such a way that the loan amount will not exceed the home value so the owner won’t be responsible to start paying for the difference between the loan amount and the home value on a monthly basis. There are specific events when this can happen, such as the home losing from its value or if the home owner lives to a very old age or time.
How Reverse Mortgages work?
Reverse mortgages can be a great thing for senior home owners that have most of their net value tied down to a property. But they can also be a poor decision that will cause stress and confusion to some. We will try and explain how exactly these loans work, how to avoid scams, so you can make the best decision before doing anything.
First, some statistics. Home owners aged 62 or older are holding around $6.5 trillion in their home equity ( based on 2017 report from the National Reverse Mortgage Lenders Association ). Ever since they started making these reports, back in the early 2000, this marks as an all time high. This means that essentially, there are a lot of very wealthy seniors that own expensive houses and can’t really use their wealth unless they sell their property or down size. Home equity is only worth something when you sell or borrow against the home value.
So how does a reverse mortgage work any way?
When taking a reverse mortgage, a home owner is basically selling a part of his home to the lender in return for a monthly cash payments. Instead of a traditional mortgage where you ask the bank or a lender to give you a large sum of money to buy a home and you pay the loan back with monthly installments over the years, with a reverse mortgage, as the name implies, the lender will make you monthly payments and you can choose how to receive the money and you only pay the interest on the proceeds received.
That interest is rolled into the loan so essentially the home owner doesn’t pay anything up front. You, as the home owner also keep the title for your home, and as the years goes by the debt increases and your home equity decreases.
Another thing to know is that similar to regular mortgages, your home is used as collateral for the loan. When the homeowner sells the house, or dies, first you need to pay the lender and repay the reverse mortgage principal, the interest, the mortgage insurance and any other fees. Anything that is left after that will go to the home owner in the event he sold the house or to his estate if he died before the home was sold. There are some cases where the heirs choose to pay off the mortgage and keep the home.
Reverse mortgage proceeds are not taxable. The IRS considers that money to be a loan advance so while it feels like income, it’s really not from a tax point of view.
The different types of reverse mortgages to consider
Today there are mainly three types of reverse mortgages that are available. These are:
- Single Purpose Reverse Mortgage
- Home Equity Conversion Mortgage
- Proprietary Reverse Mortgage
The most common out of the three is the home equity conversion mortgage or in short HECM. It is the most common and represents almost all reverse mortgages that lenders offer where the home value is below $679,650. So we will focus on this type today as it is the most likely people will get.
If your home is worth more, there are other options called Jumbo reverse mortgage AKA Proprietary reverse mortgage, but we will examine all these other options in a different article.
When you take a reverse mortgage, you can choose how you want the proceeds to be payed in one of six options:
- Lump sum – Get all the amount at once when your loan closes. This option offer a fixed interest rate and the only one out of the five, the rest have adjustable interest.
- Line of credit – You can get a line of credit to borrow as needed, meaning you will have a sum of money available and ready for you to take as needed. You will only pay the interest on money you actually borrowed, not the entire line of credit.
- Equal monthly payments – As long as at least one person who is tied to the loan lives in the house as a principal residence, the lender will keep paying the monthly payments.
- Term payments – The borrower can choose a set time for him to be payed a monthly payment. for example, 10 years. These payments are equal monthly payments for the duration of the set period of time agreed upon.
- Term payments plus a line of credit – Similar to the term payments option, the borrower will recieve equal monthly payments for a set period of time ( let’s say 10 years ) and if after or during that time he needs more money, he can get a line of credit as well.
- Equal monthly payments plus line of credit – Similar to the equal monthly payments option, as long as one principal lives in the home, he will get steady monthly payments from the lender, and if he needs more money, he can use the line of credit.
Please note you can also use what is called HECM for Purchase, which is another kind of reverse mortgage to buy another home than the one you live in now. You will need at least 50% equity in the home to pull this off, that’s home value, not what you paid for it.
Should you take a reverse mortgage or not?
There are many advantages to reverse mortgages. For example, you don’t need a great income level or even good credit score to qualify and you will not pay any loan payments as long as you live in the home you used to take out the loan. Indeed a reverse mortgage loan is very similar to home equity loans or even a line of credit.
The basic idea is similar, you get a lump sum or a line of credit that you can access and use based on your home’s market value and how much of it you already own. But where the difference lies is what we covered above in short.
It’s safe to say that a reverse mortgage might be the only option for seniors to get access to home equity without having to sell their home or without having to make monthly payments. For some it’s definitely the only option if they can’t qualify for a home equity loan or even refinance due to bad credit or low cash flow.
The pros and cons of reverse mortgage loan
PRO – As we already discussed, if you’re 62 years old or older, a reverse mortgage loan can be a great way to get some cash and keep your living style and expenses as you’re used to. When your home is your biggest asset and value, you don’t really have a better choice.
PRO – Taking a reverse mortgage will allow you to keep living in your own home as long as you are able to pay for property taxes, insurance and maintain the home you will not need to move out.
CON – On the flip side, taking a reverse mortgage comes with spending a lot of equity of your home that you worked very hard to acquire over the years, you will also pay the loan fees.
CON – It’s also very common that with a reverse mortgage you will NOT be able to pass the home to your kids or heirs, you need to consider if taking on a reverse mortgage provides a long term solution to your issues, or a short term one. If it’s a short term one, you need to think hard if it’s worth it.
CON – If you have someone living with you in the home who is not the owner, such as a relative or a roommate or even a friend, when you get a reverse mortgage, that person will have to leave the house in the event that you pass away.
CON – This is a scenario that can happen with reverse mortgages, you might just out live your loan. If you choose a payment plan that is NOT a life time payment plan, for example, a lump sum of a term plan, you can use it all up before you die and be left with no money when you need it.
Rules of the reverse mortgage loan you should know
Let’s discuss some of the rules associated with these type of loans. First, understand that if you own a house, a condo or a town house that is built after June 15, 1976, you might be eligible for a reverse mortgage. However there are restrictions on cooperative housing you should know.
Under the FHA rules ( Federal Housing Administration ), if you own a cooperative house, you CANNOT get a reverse mortgage. The reasoning behind this rule is that you are not really an owner of a home, but rather own a share of a corporation, it makes sense if you think about really.
Now while you think anyone get get a reverse mortgage since you don’t need good credit or even a good income to qualify, you do need to qualify under some very specific rules:
- You must be 62 years old or older.
- You must own a home completely or at least 50%.
- You will have to pay an origination fee.
- You will pay an up-front insurance premium, some ongoing mortgage insurance and some loan servicing fees.
- You will pay the interest of the loan.
*The federal government has limits in place on how much lenders can charge.
Lenders can’t pursue the borrower or heirs if the home is underwater when it’s time to sell. They also need to give the heirs a few months to decide what they want to do in the case of the main borrower dies. They usually need to decide if they want to pay off the reverse mortgage or give the lender permission to sell the property to cover the loan.
All those who seek to take a reverse mortgage must go through a HUD-approved counseling session. It is required by the Department of Housing and Urban Development and all borrowers do it. The sessions are at least 90 minutes long and cost around $125.
The session covers all the pros and cons of the reverse mortgage loan based on your unique financial status, it will also explain to you that taking a reverse mortgage could affect your eligibility for Medicaid and Supplemental security income. You should be aware of these things before hand and the counselor will go over all these things with you while also explaining the different ways you can get the proceeds.
The borrower responsibilities under reverse mortgage
As the borrower, you have certain responsibilities too. You must make sure the home is in good shape at all times, pay all the property taxes and home owners insurance. If you live out side of the house for more than 12 months, you will need to repay the entire loan, even if you are staying at a care facility for medical reasons.
Please note that there are risks involved by taking a reverse mortgage. Besides the scammers who try to target the senior citizen population, there are legitimate risks you should consider. There are situations where the spouse will lose the house in the event you die.
Fees of the reverse mortgage
In October 2017 the Department of Housing and Urban Development changed the insurance premiums for reverse mortgages. This affects lenders as they can’t ask the home owners or their heirs to cover the loan if the balance suddenly grows beyond the home’s value. Which we know can happen. So the insurance premiums give a fund pool so that the lenders can rely on and don’t lose their money in case the loan balance is higher than the home value.
Here’s an example of one change they made: They increased the up front premium from 0.5% to 2.0%. This applies to three out of four borrowers.
They also decreased premiums from 2.5% to 2.0% for the one out of four borrowers. In the past the up front premium as directly related to the amount the borrower would take in the first year, obviously, the borrowers who took the most, payed the highest rates.
Today, all borrowers pay the same 2.0% and the up front premium is based on the home value.
Here’s an easy example to understand this rate:
For every $100,000 in home value, you pay $2,000. So if your home is worth $400,000 you will pay $8,000 as up front premium.
To offset this increase in the higher up front premiums, the annual mortgage insurance premium was decreased from 1.25% to 0.5% of the amount you borrowed. This saves $750 per year for every $100,000 you took. This increases the chances of passing the home down to your heirs in the long run because the debt grows more slowly, keeping more of the home equity with you, the owner.
Where to get a reverse mortgage
So now that you know much more about what are reverse mortgages, you probably wonder where can you get one? So in order to land a reverse mortgage, you can’t just go to any random lender. These type of mortgages are specific and only certain type of lenders can offer them.
Just a few big names in the world of reverse mortgages include: American Advisors Group, Liberty Home Equity Solutions and One Reverse Mortgage to name a few. Please note that even though reverse mortgages are regulated under federal law, the interest rate you can get still vary, so it’s a good idea to apply with several lenders to see who will offer you the best rate.
How much interest can I expect to pay?
As we previously briefly mentioned this above, only the lump sum reverse mortgage option gives you a fixed rate interest. This type of option gives you all the funds at once when you close your loan. The other options come with adjustable rates, which actually makes sense if you think about it because you are going to borrow money for many years, and interest rates change all the time. So it wouldn’t make sense to give a fixed rate.
The adjustable interest rate is based on the London Interbank Offered Rate ( LIBOR ). Lenders also tend to take a safe margin of one to three points above the interest rate you pay, for example, if the LIBOR is at 2.5% and the lender has a 2% margin, your reverse mortgage interest rate will be a total of 4.5%.
How much money can I borrow?
You obviously can’t borrow 100% of your home’s value, not even close to it. The amount of funds you will get from a reverse mortgage will vary based on the lender you signed with and your payment plan you selected. For example, in the case of HECM, the funds you get will be based on the age of the youngest borrower, your interest rate and the home’s appraised value. In some cases it can also be the maximum you can claim based on FHA which is $679,650 ( according to 2018 ).
Here are a few other things you need to know about the amount you can borrow:
- The lower the mortgage rate, the more you can borrow.
- If you have a strong reverse mortgage financial assessment, it will increase the proceeds you will get because the lender won’t hold back part of the funds to pay property taxes and home insurance for you.
- The loan proceeds will be based on the age of the youngest borrower, or if you are married, the younger spouse, even in the case where the younger spouse is not a borrower ( a little bit confusing I know ). The older the youngest borrower is, the higher your loan proceeds will be.
- The higher your home value is, the more you can borrow.
So this is where things get a little bit tricky, the exact amount you can borrow is based on what is called the initial principal limit. And as of January 2018 it stood at an average of principal limit of $211,468 and the average maximum claim was $412,038. The average borrower initial principal limit is around 58% of the maximum claim.
Just so you know, back in 2017, the government lowered the initial principal which made it much harder for home owners, especially on the younger side to qualify for reverse mortgage. On the flip side of this though, the borrowers get to keep more of their home equity.
If you had a hard time following until now, it’s gets even more complicated, you as the borrower, can’t take all of the initial principal limits in your first year if you choose a lump sum or line of credit. You can only take up to 60% or more if you are going to use the money to pay off your standard forward mortgage.
How to void reverse mortgage scams
Whenever you mix a sensitive population like senior citizens and a lucrative product, scams are going to happen. Some home improvements contractors and vicious vendors are regularly targeting senior home owners to help them with securing a reverse mortgage to pay for home renovations or improvements. What they are basically doing is just convincing innocent people to take out loans so they can get paid.
Another few examples of reverse mortgage scams come in the form of caregivers or even relatives and financial advisors who take advantage of a vulnerable population by using a power of attorney to secure a reverse mortgage and steal the money. They also convince the seniors to buy other financial products such as annuity or expensive life insurance that the person only can afford if he or she will get a reverse mortgage. There are more examples of scams, these are just a few examples.
Reverse mortgage and your heirs or spouse
There can be tricky situations when taking a reverse mortgage and dealing with spouses. It is required that both spouses will agree and consent to the loan, but it’s possible for only one spouse to be the borrower. You can see why this could be a problem right?
What happens if two spouses live together but only one spouse is named the borrower? The other spouse is going to be at risk of losing the house in the event of the borrowing spouse dies first. When the borrower dies the reverse mortgage must be repaid and this usually happens by selling the property. If the remaining spouse wants to stay in the house he or she will have to secure a different kind of financing to repay the reverse mortgage, which can be expensive.
A more ideal situation is that both spouse will hold the title to the house, and both spouses will be the borrowers of the reverse mortgage. This way, if one of the spouses dies first, the other one can carry on the mortgage with no issues. Again, if only one spouse is the borrower, the other spouse might lose the house even in the event that the borrower is forced to move out of the house due to medical conditions and stays out of it for a year or more.
How to void foreclosure
So while you might think that a foreclosure case with a reverse mortgage is impossible because the borrower doesn’t have to make any monthly payments, this is not entirely true. When securing a reverse mortgage, there are conditions that the borrower must meet, and in an event that he doesn’t, the lender can issue a foreclosure on the property.
The most common example of a foreclosure situation is where the borrower neglects the home. A reverse mortgage borrower is required to keep the home in good shape. If the home is neglected it might lose some of its value when it’s time to sell and the lender won’t get the full amount he was expecting.
Reverse mortgage borrowers are also required to pay all property taxes and home owner insurance, if you don’t pay your home taxes the local tax authority can seize your house and you will lose it. If you don’t take out a home insurance and there’s a flood or fire, the lender’s collateral might be damaged.
You search for what is a reverse mortgage and we hope we provided you with all the info you need to make the right decision. A reverse mortgage can be a very helpful tool for senior home owners, but only if you really understand how they work, and what are the risks involved.
Please take the time to fully learn and understand all the rules and regulations before making any decision. Don’t forget that even if the reverse mortgage is secured with a reputable lender, it is still a very complicated financial tool and you should take the time to understand it completely.