What is a Reverse Mortgage?
If you are an older homeowner and are looking for a way to access the equity you’ve built up in your home, a Reverse mortgage might be the right choice for you. 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 borrowers who have limited income to better manage their finances once they have retired. By allowing them to pull equity from their home, they can then use that equity to cover living expenses and increase their freedom with their retirement funds.
Reverse Mortgage Overview
A Reverse mortgage is one of the home loans backed by the Federal Housing Administration (FHA). This means it is guaranteed by the federal government. With a Reverse mortgage, your lender makes monthly payments to you instead of a traditional mortgage where you would be making payments to your lender. As long as you live in the home, those monthly payments will be available to you. This is why it’s called a Reverse mortgage. The loan is not required to be paid back until the home is sold, vacated, or the owner passes away. The homeowner also retains ownership of the home. However, you must remain current on property taxes, homeowners insurance, homeowners association dues, and any other applicable fees. You must also be able to maintain the property.
How a Reverse Mortgage Works
Another name for a Reverse mortgage is a Home Equity Conversion Mortgage or HECM. The name describes what takes place. You convert some of your home equity into cash with a new Reverse mortgage.
Unlike a traditional mortgage that you may have used to purchase your home, a Reverse mortgage doesn’t have to be repaid for as long as you live in your home. You get the money, you keep the title of your home, and you get to continue living in your home without the burden of monthly mortgage payments. This can make it a valuable option if you want to stay in your home longer.
The amount of cash you receive is based on a combination of factors: Your age (one borrower must be at least 62 years of age or older) the prevailing interest rate, and the value of your home. You can receive your money in a lump sum, over a period of years (term), monthly installments for life (tenure), or as a line of credit (LOC). If you choose to use an LOC, you will only be charged interest on the money that you use. You can also mix your options like receiving a mini-lump sum at closing then get the remainder in installments over the duration of the loan.
The money you get is also tax-free (because it’s technically a loan) and it will not affect your Social Security, Medicare, or pension. However, it may impact Medicaid or SSI recipients, so always speak with your financial advisor or tax consultant before moving ahead with a Reverse mortgage.
The final loan amount due will be a total of the interest that has compounded on your loan and the principal. The original loan amount will include all origination fees, closing costs, plus the cost of mortgage insurance financed into the loan. If your heirs choose to pay off the loan by selling the home and the loan amount due is larger than the sale proceeds, your heirs aren’t responsible for making up the difference. The FHA will make up the shortfall from the upfront insurance you paid to obtain the loan and the monthly insurance premiums paid over the life of your loan.
Reverse Mortgage Benefits
Reverse mortgages come with their own unique set of benefits including:
- No credit score qualification: Unlike other loans, Reverse mortgages do not have a minimum credit score requirement.
- No debt-to-income ratio: Reverse mortgages do not have a required limit on your DTI. However, you must be able to demonstrate the ability to pay the basic obligations of owning a home like maintenance, other bills, and any associated fees.
- Provides greater freedom once you retire: There are no restrictions on how you can use the funds you receive from a Reverse mortgage. You can use the money to pay for medical bills, fund investments, or to supplement your retirement income.
- Non-recourse loan: This means that if the borrower defaults on the loan, the lender can only pursue the agreed upon collateral and nothing more.
- Financial benefits: A Reverse mortgage can help a borrower retain their savings, improve their monthly cash flow, and / or finance a purchase.
- Relocation: A Reverse mortgage can provide you with the opportunity to relocate to a different city or move closer to family members.
- Changing your living situation: A Reverse mortgage can also be used to help you move into a more affordable home, one that requires less maintenance, or better serves your physical needs.
- Age in place: If you don’t want to move then a Reverse mortgage can help you stay in your home.
- Tax-free money: The money you get from a Reverse mortgage is technically a loan, even if you receive it as a lump sum upfront. It does not count as income; therefore it is not taxed. This tax-free income can be used for any purpose including investing or paying for needed home repairs.
Reverse Mortgage: What to Watch Out For
Reverse mortgages are extremely beneficial to many borrowers. However, as with all mortgages, there are some factors that should be considered before making a final decision. Here are some general features of a Reverse mortgage that borrowers should consider.
- Closing costs and fees tend to be higher with a Reverse mortgage than they are for other loans like a Conventional loan.
- Reverse mortgage interest rates are often higher than those for other 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. Your heirs will also be tasked with repaying the loan.
- Borrowers must keep up on real estate taxes, homeowners insurance, and home maintenance in order to uphold their side of the loan agreement.
Your loan will also have its own unique set of terms and conditions agreed upon between you and your lender. For more information on how Reverse mortgages work, take a look at our blog, “How a Reverse Mortgage Works.”
If you are at least 62 years old and are considering a Reverse mortgage, talk to a financial planner today. You can also reach out to our loan officers at New American Funding. They will be happy to answer any of your questions, help you find the mortgage that is right for your circumstances and guide you through the application process.
Reverse Mortgage Requirements
Each mortgage lender will have their own requirements for approval. Here are some general requirements to qualify for a Reverse mortgage.
- Borrowers must be 62 years old or older: If you are borrowing as a married couple and both your names are on the mortgage, the loan amount will be based on the age of the youngest applicant.
- Ability to pay other homeownership costs: Borrowers must qualify to pay taxes, insurance, or HOA fees, if applicable
- The property must be the primary residence of the borrower: The property must be owned by the borrower outright or have a low enough balance left on the mortgage that it can be paid off at closing with money from the Reverse mortgage. If the property is not owned outright, the borrower must have considerable equity in their home. Many mortgage lenders require a minimum of 50% equity to qualify you for the loan.
- Property maintenance: Borrowers must be able to maintain the property and pay any fees associated with it
- HUD-required counseling: All borrowers and non-borrowing spouses are obligated to receive independent counseling. This is to protect the consumer and make sure that everyone involved understands the details of Reverse mortgages. Each session costs around $125 and lasts around 90 minutes. Your counselor will walk you through the workings of a Reverse mortgage and will explain the effects that the loan could have on your Medicaid and Supplemental Security Income. They will also explain how the loan works and what payment options are available to you.
While the cost of a Reverse mortgage can vary depending on the lender and your individual circumstances, there are some general costs that include the following:
Origination fee: The fee paid to the lender for originating your loan. This can vary according to the lender but has limitations set 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. The exception to this is the lump sum option. If you choose this option, you will receive the money from the loan in one lump sum at closing. This is the only payment option that has a fixed interest rate.
3rd party closing costs: These fees can vary by lender and include appraisal fees and credit checks for both borrowers.
Fee for service: Though they are less common than they were in the past, there is still sometimes a fee associated with the cost of servicing your loan.
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.
Government agencies regulate how much lenders can charge for many mortgage costs. It’s a good idea to compare these costs when looking into a Reverse mortgage to determine the type of loan that is best for your individual circumstances.
Types of Reverse Mortgage Payments
- Lump sum: Receive all of your money when the loan closes. This option is the only one that has a fixed interest rate.
- Equal monthly payments: The lender will make monthly payments to the borrower. This will continue for as long as the borrower lives in the home.
- Line of credit: Works similarly to a credit card. This is a line of credit that is made available to the borrower. They can pull from this whenever they need and will only pay interest on the money they borrow from the line.
- Term payments: This is the same as the equal monthly payments option. The only difference is that the payments will continue for a specific period of time agreed upon by the lender and the borrower.
- Equal monthly payments plus a line of credit: The lender will make monthly payments to the borrower. This will continue for as long as the borrower lives in the home. If you need more money in addition to the monthly payments, there is a line of credit available for you to access as well.
- Term payments plus a line of credit: Term payments are monthly payments made to the borrower by the lender for a certain period of time. If you need more money in addition to the monthly payments, there is a line of credit available for you to access as well.
You can also mix your options, say, receive a mini-lump sum and receive the remainder in installments. For lump sums and lines of credit, a first-year withdrawal limit of 60% may apply. This limit was implemented to protect borrowers.
How Much Can You Borrow with a Reverse Mortgage?
The amount you can obtain with a Reverse mortgage depends on several different factors. They include the appraised value of the home, the current mortgage balance, how old the borrower is, and the current interest rate.
Use the mortgage calculator on the New American Funding website to calculate your estimated mortgage costs.
How to avoid Reverse mortgage scams
There are a few types of scams that can relate to Reverse mortgages. These scams can come from companies or individuals. There are house flipping scams, equity theft, and foreclosure scams. Relatives or other personal advisors, like financial planners, may convince you to get a Reverse mortgage when you don’t actually need one then pocket the money.
Fortunately, there are things you can pay attention to and do that will help you avoid any Reverse mortgage, or other home loan scams.
Do your research: Before trusting a lender or banker who is offering to secure you a home loan, look them up. Check out their online presence, their social media, their website, and read reviews. Find out if they've helped other seniors like you. Verify them wherever possible using websites like the Better Business Bureau. Find out if they have a reputation as a dependable business, verify their business status, make sure they have a license, and if something feels off, trust your gut and find a different lender. It is also a good idea to research and understand your rights as a consumer.
Talk to people you trust: This can be family members or experts. Any professional you know like an attorney, or financial advisor that you know have your best interests at heart. By getting advice early on, you may be able to avoid later confusion and catch misinformation early.
Understand the paperwork: Reverse mortgages and other home loans can be complicated. They can have a lot of paperwork that contains terms, conditions, and the details of your loan agreement. It is important that you understand everything before you sign anything. Make sure to read everything thoroughly and ask whatever questions you have. It is always best to have someone you trust, like an attorney, look over any paperwork before you sign it.
Do not reply to unsolicited contact: Whether this takes the form of ads in the mail, emails, or phone calls, it is best to not provide a response when you are being unexpectedly offered a loan.
Use your resources: Most mortgage lenders require you to complete independent counseling before they will approve you for the loan. However, it is a good idea to take this counseling regardless of whether or not it is required as it will provide you with the information to help you decide what is right for you. The HUD also has a variety of resources for borrowers to help borrowers stay protected including information and assistance programs.
It’s also important to note that the VA does not offer Reverse mortgages. So, if you are a veteran, pay special attention to anyone offering you a supposedly VA-approved Reverse mortgage.
What is the downside to a Reverse mortgage?
Reverse mortgages have been beneficial to many homeowners. However, there are some things to be aware of. The fees and closing costs associated with a Reverse mortgage are often higher than those associated with other loans. The interest rates lenders charge on Reverse mortgages are also often higher than those of other loans. Like with other loans, your home is being used as collateral against the loan, so that comes with its own potential risks. It is also possible that borrowers can use up a lot of the equity of their home. This can leave them with less inheritance to pass on to their heirs.
What happens when the owner of a Reverse mortgage dies?
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.
If both borrowers die, then the heirs will receive a notice that the loan is due. They can sell the home to pay the remaining balance of the Reverse mortgage. They can also take out a new mortgage if they decide they want to keep the home.
How to buy out a Reverse mortgage?
Reverse mortgages can be refinanced or paid off in full. You can do this several different ways. In order to pay off a Reverse mortgage you will either need to sell the house or have an independent source of income must be available to the borrower. The loan balance must be paid in full including the interest in accordance with the stated conditions of the loan. There is also no prepayment penalty should you choose to pay off the loan early.
You can also refinance a Reverse loan. Refinancing is when you replace your existing mortgage with a new one. Reverse mortgages are governed by The United States Department of Housing and Urban Development (HUD). HUD states that borrowers can refinance their reverse mortgage after 12 months. It is possible to refinance a Reverse mortgage into another Reverse mortgage with better terms or into a Conventional loan.
Will a Reverse mortgage affect my benefits?
While a Reverse mortgage will not affect your Social Security or Medicare, it might affect your eligibility for 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 passing away, if the owners have moved, for example to an assisted living facility, or if the condition of the home degrades too far.