What Is A Reverse Mortgage?

If you’re a homeowner and think that an investment to help provide you additional income during your retirement years sounds attractive, you may want to look into a reverse mortgage. Many folks like you use these funds to supplement Social Security or other income, meet medical expenses, pay for in-home care and make home improvements.

reverse mortgage

As reverse mortgages are not well understood by most folks, here’s some background information to help you decide if this is a suitable investment for you.

 

Basics Of Reverse Mortgages

A reverse mortgage is a type of loan, typically in the form of a line of credit, that allows homeowners - ages 62 and older who’ve paid off their mortgage or have, at least, 50% equity - to borrow part of their home’s equity as tax-free income. Vacation homes or rental properties are not eligible.

Unlike a regular mortgage in which you make payments to a lender, with a reverse mortgage, the lender pays you. If you elect to do this, this kind of mortgage won’t have a monthly payment and you don’t have to sell your home - in other words, you can continue to live in it. However, when the primary homeowner dies or moves, the mortgage is payable in full. If you can’t, or won’t, pay off the debt, the lender can then sell your home to recover the money it’s owed.

You have flexibility in the ways to receive the money from the lender: a lump sum, a monthly payment, a line of credit or a combination.

If the value of your home appreciates and becomes worth more than the reverse mortgage loan balance, you or your heirs may receive the difference.

Your reverse mortgage becomes due after your death. The title remains with your family members or heirs. They can keep the home either by repaying the loan or refinancing the note with a new conventional mortgage or the lender will sell your home to pay off the balance of the loan. The repayment of whatever amount of a loan balance may be deferred until the last borrower or non-borrowing spouse either dies, moves or sells the home.

 

Reverse Mortgages Explained In Detail

As mentioned, to be eligible for a reverse mortgage, the primary homeowner must be age 62 or older. In addition:

  • You must own the property outright or have at least paid down a substantial amount (50%, or more) of your mortgage.
  • The property must be occupied as your primary residence.
  • You cannot be delinquent on any federal debt.
  • You must have the financial capability to continue to make payments on property taxes, homeowners insurance and any homeowners association dues.
  • You must participate in an information session provided by a U.S. Department of Housing and Urban Development (HUD)-approved reverse mortgage counselor.
  • Even if the mortgage is paid off, qualified homeowners may not be able to borrow the entire value of their home.
  • One of the most popular types of reverse mortgages is the Home Equity Conversion Mortgage (HECM), which is backed by the federal government.

The amount a homeowner can borrow, known as the principal limit, varies based on the age of the youngest borrower or eligible non-borrowing spouse, current interest rates, the HECM mortgage limit ($822,375 in 2021) and the home’s appraised value.

Homeowners are likely to receive a higher principal limit the older they are, the more the property is worth and the lower the interest rate. The amount might increase if the borrower has a variable-rate HECM. With a variable rate, options include:

  • Equal monthly payments, provided at least one borrower lives in the property as their primary residence
  • Equal monthly payments for a fixed period of months agreed on ahead of time
  • A line of credit that can be accessed until it runs out
  • A combination of a line of credit and fixed monthly payments for as long as you live in the home
  • A combination of a line of credit plus fixed monthly payments for a set length of time

If you choose a HECM with a fixed interest rate, on the other hand, you’ll receive a single-disbursement, lump-sum payment.

 

Different Types Of Reverse Mortgages

There are different types of reverse mortgages. Each fits a different financial need.

If you need a fixed amount for a specific repair or a tax bill, then a single-purpose reverse mortgage is the cheapest option if you can find one.

If you have a high-value property and need more than the lending limit, your only option is a proprietary reverse mortgage. If you don't meet either of those criteria, then a standard HECM is your best option.

    Home Equity Conversion Mortgage (HECM)

    The most popular type of reverse mortgage, these HUD-insured mortgages usually have higher upfront costs…but the funds can be used for any purpose. In addition, you can choose how the money is withdrawn, such as fixed monthly payments or a line of credit (or both options simultaneously).

    Although widely available, HECMs are only offered by Federal Housing Administration (FHA)-approved lenders, and before closing, as also noted above, all borrowers must receive HUD-approved counseling.

    Proprietary Reverse Mortgage

    This is a private loan not backed by the government. You can typically receive a larger loan advance from this type of reverse mortgage, especially if you have a higher-valued home.

    Single-Purpose Reverse Mortgage

    This mortgage is not as common as the other two. It’s usually offered by nonprofit organizations and state and local government agencies. A single-purpose mortgage is generally the least expensive of the three options; however, as the title suggests, borrowers can only use the loan (which is typically for a much smaller amount) to cover one specific purpose, such as a handicap accessible remodel.

 

Because proprietary reverse mortgages are not federally insured, they don’t have up-front or monthly mortgage insurance premiums (MIPs). That means you can probably borrow more.

Whether this makes it better than a HECM depends on the lender's interest rate and how much they're willing to advance based on the home's value to compensate for the lack of mortgage insurance. It’s also important to be aware that, regardless of the type of reverse mortgage, you shouldn’t expect to receive the full value of your home. Instead, you’ll get a percentage of that value.

The amount you receive will also be affected if your home has any other mortgages or liens. Other considerations include if there’s a balance from a home equity loan or home equity line of credit (HELOC), for example, as well as any tax liens or judgments. Those obligations will have to be paid with the reverse mortgage proceeds first.

 

How Much Does A Reverse Mortgage Cost?

The closing costs for a reverse mortgage aren’t particularly cheap, but the majority of HECM mortgages allow you to roll the costs into the loan so you don’t have to shell out the money upfront. Doing this, however, reduces the amount of funds available to you through the loan.

Here’s a breakdown of HECM fees and charges, according to HUD:

  • Mortgage insurance premiums (MIP) – There is a 2 percent initial MIP at closing, as well as an annual MIP equal to 0.5 percent of the outstanding loan balance. The MIP can be financed into the loan.

  • Origination fee – To process your HECM loan, lenders charge the greater of $2,500 or 2 percent of the first $200,000 of your home’s value, plus 1 percent of the amount over $200,000. The fee is capped at $6,000.

  • Servicing fees – Lenders can charge a monthly fee to maintain and monitor your HECM for the life of the loan. Monthly servicing fees cannot exceed $30 for loans with a fixed rate or an annually adjusting rate, or $35 if the rate adjusts monthly.

  • Third-party fees – Third parties may charge their own fees, as well, such as for the appraisal and home inspection, a credit check, title search and title insurance, or a recording fee. Read the fine print.

Keep in mind that the interest rate for reverse mortgages tends to be higher, which can also add to your costs. Rates can vary depending on the lender, your credit score and other factors. Further, the interest on a reverse mortgage accrues every month. You’ll still need to have adequate income to continue to pay for property taxes, homeowners insurance and upkeep of your home.

 

Pros & Cons Of A Reverse Mortgage

While borrowing against your home equity can free up cash for your daily living expenses, the mortgage insurance premium and origination and servicing fees can add up. Here are some advantages and disadvantages of a reverse mortgage.

Pros

  • As a loan, the proceeds are not included in high-income Medicare premiums or the taxation of your Social Security benefits
  • You don’t need to make monthly payments toward your loan balance
  • Proceeds can be used for living and healthcare expenses, debt repayment and other bills
  • Funds can help you enjoy their retirement
  • Non-borrowing spouses - not listed on the mortgage - can remain in the home after the borrower dies
  • Borrowers facing foreclosure can use a reverse mortgage to pay off the existing mortgage, potentially stopping the foreclosure

Cons

  • A home with a reverse mortgage can be foreclosed on if the homeowner moves out of the property, fails to keep the property in good repair, fails to keep homeowners insurance current on the property, or fails to pay property taxes. Even if a homeowner moves out of the property involuntarily (that is, due to an extended stay in a care facility) if they’re gone for over a year, then the reverse mortgage becomes due and if the homeowner fails to pay, the property will be foreclosed on.
  • You must maintain the house and pay property taxes and homeowners insurance
  • Forces you to borrow against the equity in your home, which could potentially be a key source of retirement funds
  • Fees and other closing costs can be high and will lower the amount of cash that’s available
 

Can You Lose Your House With A Reverse Mortgage?

There are conditions for keeping your reverse mortgage in good standing and, if you fail to meet them, you could lose your home.

The ways you could violate the terms of a reverse mortgage include:

  • The home is no longer your primary residence. As part of the reverse mortgage agreement, the home must be your primary residence. This means that you cannot leave the home for more than 12 consecutive months. This doesn’t bar you from leaving your home to travel or to come and go as you please, but, as noted above, if you vacate the property for 12 consecutive months, the reverse mortgage loan becomes eligible to be called due and payable.
  • You decided to move or sell your home. If you have to move and put your home up for sale as part of the move, you’re still bound by the requirement to live in the house for 12 consecutive months. If selling your home becomes a challenge and you don’t find a buyer within that 12-month window, the reverse mortgage can still be called due.
  • You don’t pay your property taxes or homeowners insurance. Even with a reverse mortgage, you’re still responsible for paying property taxes. Failure to do so could violate the terms of your loan. In addition, you must maintain current homeowners’ insurance.

If you fail to pay property taxes, for example, or keep the home properly insured, the loan servicer could advance available loan proceeds from the reverse mortgage to cover these expenses. If there are not adequate proceeds available to cover these types of payments, the servicer could elect to advance its own funds to make the outstanding payments.

 

Other Considerations

If the loan balance exceeds the home’s value, you or your heirs may need to foreclose or otherwise give ownership of the home back to the lender.

There are also potential complications involving others who live in the home with the borrower, and what might happen to them if the borrower dies. Family members who inherit the property will want to pay close attention to the details of what is necessary to manage the loan balance when the borrower dies.

Additionally, while not all reverse mortgage lenders use high-pressure sales tactics, some do use them to attract borrowers.

It’s almost always best to receive guidance from a nonprofit agency that offers reverse mortgage counseling before signing a loan agreement. Taking advice, without getting the facts from a trusted, independent resource, can leave you with a major financial commitment that may not be good for you.

 

Next Steps

If a reverse mortgage still feels like a good idea for you, take time to research your options.

It’s best to speak with a HUD-approved counselor before committing to a reverse mortgage (and if you want a HECM, you’ll be required to). A counselor can help you outline the pros and cons and how this kind of loan might affect your heirs after you pass away.

To locate an FHA-approved lender or HUD-approved counseling agency, you can visit HUD’s online locator or call HUD’s Housing Counseling Line at 800-569-4287.

   

Guest post written by Michael Maehl.

Mike Maehl - speaking about reverse mortgages

Mike Maehl’s investment career began in 1973 with his training at 120 Broadway in New York after graduating from Northern Illinois University in 1967 and serving in Vietnam as an infantry platoon commander in the Marine Corps.

Mike joined Opus 111 Group as a Senior Vice President and head of its Spokane office in 2008. In 2020, Mike established an additional office in Arizona and actively serves clients in both locations. He hosts a weekly hour-long call-in program on investing, the markets and the economy called ‘Money Management’ on Saturdays at 9am Pacific. He can be heard live online by going to kxly920 and clicking on listen.

Contact him at m.maehl@opus111group.com for more information.