reverse morgtage

Reverse Morgtage - What Is a Reverse Morgtage?

A reverse morgtage enables eligible homeowners to borrow money against the value of their homes, but it operates differently from a traditional home purchase loan. Homeowners who are 62 or older and have substantial home equity can access funds as a lump sum, fixed monthly payment, or line of credit. This type of mortgage does not require borrowers to make any loan payments during their lifetime, unlike forward mortgages used for purchasing homes.

Instead, the borrower’s entire loan balance, subject to a limit, becomes due and payable when they die, move out permanently, or sell their home. To comply with federal regulations, lenders structure the transaction to ensure that the loan amount does not exceed the home's value. If it does, and the home's market value declines or the borrower outlives their life expectancy, the borrower or their estate will not be responsible for paying the lender the difference, thanks to the program's mortgage insurance.

A reverse mortgage is a type of loan that allows homeowners to convert a portion of their home equity into cash. Unlike a traditional mortgage where you make payments to a lender, with a reverse mortgage, the lender makes payments to you.

How Does A Reverse Mortgage Work?

A reverse mortgage is a type of loan designed for homeowners who are 62 years of age or older and have considerable equity in their home. Instead of the homeowner making monthly payments to a lender as with a traditional mortgage, a reverse mortgage allows the borrower to receive payments from the lender.

The amount a borrower can receive from a reverse mortgage depends on several factors, including the borrower's age, the value of their home, and the current interest rate. Borrowers can choose to receive the money as a lump sum, fixed monthly payments, or a line of credit.

Unlike traditional mortgages, with a reverse mortgage, the borrower does not have to repay the loan until they move out of their home, sell it, or pass away. When the loan becomes due, the borrower or their heirs can repay the loan balance by selling the home, using other assets, or refinancing the loan. If the loan balance is greater than the home's value, the borrower or their heirs are not responsible for the difference, thanks to the federal government's insurance program.

Reverse mortgages can be an excellent option for seniors who need cash and have substantial equity in their homes. However, it is important to understand that these loans can be complex and expensive, so it is essential to carefully consider the pros and cons before deciding if a reverse mortgage is right for you. It is also recommended to work with a reputable lender and a trusted financial advisor to ensure that you fully understand the loan terms and the potential impact on your finances.

How a Reverse Morgtage Works

A reverse mortgage is a loan where the lender pays the homeowner instead of the other way around. Homeowners who qualify can choose how to receive the payments and only pay interest on the proceeds they receive. The interest is rolled into the loan balance, so no upfront payment is necessary, and the homeowner retains the title to the home. Over time, the loan balance increases, and the homeowner's equity decreases.

Similar to a traditional mortgage, the home serves as collateral for the reverse mortgage. When the homeowner either moves out or passes away, the lender collects the proceeds from the home's sale to repay the reverse mortgage's principal, interest, mortgage insurance, and fees. If there are any remaining funds, the homeowner (if still alive) or the homeowner's estate (if deceased) receives them. In some cases, the heirs may decide to pay off the mortgage to keep the home.

Types of Reverse Mortgages

There are three types of reverse mortgages, but the most common one is the home equity conversion mortgage (HECM). This type of mortgage is offered by lenders on home values below the conforming loan limit and is available through an FHA-approved lender. A jumbo reverse mortgage, also called a proprietary reverse mortgage, is available for homes worth more.

There are three types of reverse mortgages:

  1. Home Equity Conversion Mortgage (HECM): This is the most common type of reverse mortgage, and it is insured by the Federal Housing Administration (FHA). HECMs are available through FHA-approved lenders and are only available to homeowners who are 62 years of age or older. The amount of money that can be borrowed is determined by the borrower's age, the home's value, and current interest rates. HECMs offer a choice of payment options, including a line of credit, a lump sum payment, or fixed monthly payments.
  2. Proprietary Reverse Mortgage: This type of reverse mortgage is not insured by the FHA and is instead offered by private companies. Proprietary reverse mortgages may offer higher loan limits and more flexible payment options than HECMs, but they also may have higher fees and interest rates.
  3. Single-Purpose Reverse Mortgage: This type of reverse mortgage is offered by some state and local government agencies and nonprofit organizations. Single-purpose reverse mortgages are designed to be used for one specific purpose, such as home repairs or property taxes, and typically have lower costs than other types of reverse mortgages. However, they may also have more limited payment options and borrowing amounts.

When taking out a reverse Morgtage, the borrower can choose from six ways to receive the proceeds:

  • Lump sum: The borrower receives all the proceeds when the loan closes, and this option comes with a fixed interest rate.
  • Equal monthly payments (annuity): The lender provides the borrower with steady payments for as long as at least one borrower lives in the home as a principal residence. This is also known as a tenure plan.
  • Term payments: The borrower receives equal monthly payments for a set period of their choosing.
  • Line of credit: Money is available for the homeowner to borrow as needed, and the homeowner only pays interest on the amounts borrowed from the credit line.
  • Equal monthly payments plus a line of credit: The lender provides steady monthly payments, and if the borrower needs more money, they can access the line of credit.
  • Term payments plus a line of credit: The borrower receives equal monthly payments for a set period of their choosing, and they can access the line of credit if they need more money during or after that term.

It is also possible to use a reverse mortgage called a "HECM for purchase" to buy a different home than the one in which the borrower currently lives.

In any case, the borrower typically needs at least 50% equity based on the home's current value to qualify for a reverse mortgage.

Who Is a Reverse Morgtage Right For?

While a reverse mortgage may seem similar to a home equity loan or a home equity line of credit (HELOC), it operates differently. Like these loans, a reverse mortgage allows you to access a lump sum or a line of credit based on your home's value and how much you've paid off. However, unlike a home equity loan or HELOC, you won't need a good credit score or income to qualify for a reverse mortgage. You also won't have to make any loan payments while you live in the home.

For seniors who don't want to make monthly loan payments or can't afford to, a reverse mortgage can be a useful option. It's also beneficial for those who don't qualify for a home equity loan or a cash-out refinance due to limited cash flow or poor credit. However, other loans like unsecured personal loans may also be available to seniors who need a lump sum of cash. Keep in mind that such loans require monthly repayment and don't provide the option of using the home as collateral.

What Is Required for a Reverse Morgtage?

Property Type

If you possess a house, townhouse, condominium, or a manufactured home constructed after June 15, 1976, you may qualify for a reverse mortgage. However, under FHA regulations, those who own cooperative housing cannot get reverse mortgages because they don't own the actual property they live in; rather, they possess shares in a corporation. In New York, where co-ops are prevalent, state law imposes additional restrictions on reverse mortgages, limiting them to one-to-four family homes and condos only.

Age, Equity, and Fees

Although reverse mortgages do not have strict income or credit score requirements, they do have eligibility guidelines. You must be at least 62 years old and have a significant amount of equity in your home, or you must own your home outright. To qualify for a reverse mortgage, you will be required to pay an origination fee, an upfront mortgage insurance premium, as well as other standard closing costs. Ongoing mortgage insurance premiums (MIPs), loan servicing fees, and interest will also be charged. However, the federal government limits how much lenders can charge for many of these items.

Counseling

Before taking out a reverse mortgage, prospective borrowers in the United States must complete a counseling session approved by the Department of Housing and Urban Development (HUD). The session, which typically costs around $125, should last at least 90 minutes and cover the advantages and disadvantages of taking out a reverse mortgage based on the individual's specific financial and personal situation. It should also address how a reverse mortgage could affect eligibility for Medicaid and Supplemental Security Income (SSI). The counselor is expected to explain the various options for receiving the proceeds.


What Are the Costs of a Reverse Morgtage?

In October 2017, HUD made changes to the insurance premiums for reverse mortgages. These insurance premiums protect lenders from losing money if the loan balance becomes larger than the home’s value. One of the changes was an increase in the up-front premium for three out of four borrowers, from 0.5% to 2.0%, and a decrease for the other one out of four borrowers, from 2.5% to 2.0%. Previously, the up-front premium was based on how much borrowers took out in the first year, but now all borrowers pay the same 2.0% rate based on the home’s value. This means that for every $100,000 in appraised value, the borrower pays $2,000, with a maximum fee of $6,000 even for homes worth more than $300,000.

In addition to the up-front premium, all borrowers are required to pay annual mortgage insurance premiums (MIPs) of 0.5% (previously 1.25%) of the amount borrowed. This change saves borrowers $750 per year for every $100,000 borrowed, and it helps offset the higher up-front premium. It also means that the borrower’s debt grows more slowly, which preserves more of their equity over time, provides a source of funds later in life, and increases the likelihood of being able to pass down the home to heirs.

Reverse morgtage Interest Rates

The lump sum reverse mortgage is the only option with a fixed interest rate, meaning you receive all the proceeds at once when the loan closes. The other five choices come with adjustable interest rates, which is understandable since the money is borrowed over many years and interest rates often fluctuate. These variable-rate reverse mortgages are connected to a benchmark index, such as the Constant Maturity Treasury (CMT) index.

The lender typically adds a margin of one to three percentage points to the base rates. So, if the index rate is 2.5% and the lender’s margin is 2%, the reverse mortgage interest rate will be 4.5%. Interest accrues over the life of the reverse mortgage, and your credit score has no bearing on your reverse mortgage rate or eligibility. However, your credit score may impact whether the lender requires a Life Expectancy Set Aside account for your property taxes, homeowners insurance, and other property charges.

How Much Can You Borrow with a Reverse Morgtage?

The amount you can receive from a reverse mortgage depends on the lender and your payment plan. For an HECM loan, the amount you can borrow is determined by the youngest borrower's age, the 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.

However, you cannot borrow the full value of your home or even close to it. Some of your home equity must be used to pay for expenses, such as mortgage premiums and interest. Here are a few other factors to consider when determining how much you can borrow:

  • The loan proceeds are based on the age of the youngest borrower or spouse, even if they are not a borrower. The older the youngest borrower is, the higher the loan proceeds.
  • A lower mortgage rate means you can borrow more.
  • A higher appraised value of your property means you can borrow more.
  • A strong financial assessment can increase the proceeds you receive, as the lender won't withhold part of them to pay property taxes and homeowners insurance on your behalf.
The amount you can borrow is based on the initial principal limit, which the government lowered in October 2017 to help borrowers preserve more of their equity. The federal government made this change because the mortgage insurance fund's deficit had almost doubled over the past fiscal year, and the limit reduction would help pay lenders and protect taxpayers from reverse mortgage losses.

Additionally, if you choose a lump sum or a line of credit, you can't 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 money to pay off your forward mortgage. If you choose a lump sum, you receive the full amount upfront, whereas if you choose the line of credit, your credit line will grow over time, but only if you have unused funds in your line.

Avoiding Reverse Morgtage Scams

Reverse mortgages can be a potentially lucrative product, but unfortunately, scams often target the vulnerable population of borrowers who may be seeking financial help or have cognitive impairments. Unscrupulous vendors and home improvement contractors have been known to exploit seniors by offering to help them secure reverse mortgages to pay for home improvements, with the goal of profiting off the homeowner. The vendor or contractor may not deliver on promised quality work or may even steal the homeowner’s money.

In addition to these scams, relatives, caregivers, and financial advisors have taken advantage of seniors by using a power of attorney to obtain a reverse mortgage on the home, and then stealing the proceeds. They may also convince seniors to buy financial products, such as annuities or whole life insurance policies, that they can only afford by obtaining a reverse mortgage. Unfortunately, in these cases, the transaction is often only in the best interest of the financial advisor, relative, or caregiver, and not the homeowner. These are just a few examples of the reverse mortgage scams that can harm unsuspecting homeowners.

How to Avoid Reverse Morgtage Foreclosure 

One of the potential risks associated with a reverse mortgage is the risk of foreclosure. Although the borrower is not required to make mortgage payments, there are certain conditions that must be met, failure to which the lender may foreclose.

Reverse morgtage borrowers must reside in the home and maintain it. If the property is not well taken care of and falls into disrepair, its market value will decrease, and the lender may not be able to recoup the full amount it has extended to the borrower.

In addition, reverse mortgage borrowers are obligated to keep up with property taxes and homeowners insurance payments. These requirements are imposed by the lender to safeguard their interest in the property. If property taxes are not paid, the local tax authority can seize the home, and if the borrower does not have homeowners insurance, the collateral is at risk of damage if there is a house fire.

Is a Reverse Morgtage Expensive?

A reverse morgtage can be expensive because it typically includes closing costs and fees such as appraisal fees, origination fees, and mortgage insurance premiums. The exact cost of a reverse mortgage will depend on several factors, including the lender, the type of reverse mortgage, the interest rate, and the amount of equity in the home.

One of the main costs of a reverse mortgage is the mortgage insurance premium (MIP), which is required for all Home Equity Conversion Mortgages (HECMs), the most common type of reverse mortgage. The MIP is used to protect the borrower and the lender, and it can be as high as 2% of the home's appraised value.

Other costs associated with a reverse mortgage may include an appraisal fee to determine the home's value, an origination fee to cover the lender's expenses, and third-party fees such as title search and recording fees. These costs can add up quickly and may be paid upfront or rolled into the loan, which can increase the total amount of interest charged over the life of the loan.

It's important for prospective borrowers to carefully consider the costs associated with a reverse mortgage and compare them to other financial options before making a decision. Working with a reputable lender and seeking advice from a financial advisor can also help to ensure that a reverse mortgage is the right choice for a particular individual's financial situation.

When Do You Have to Repay a Reverse Morgtage?

If a borrower engages in any of the following activities, the lender will demand repayment of the reverse mortgage:
  • Sells the home
  • Resides outside the home for over a year
  • Passes away
  • Fails to maintain the property
  • Stops paying for property taxes or homeowners insurance premiums
However, eligible non-borrowing spouses who wish to continue living in the house after their borrowing spouse dies may be exempt from these requirements under certain circumstances.

Can You Owe More Than the Home Is Worth with a Reverse Morgtage?

Yes, it is possible to owe more than the home is worth with a reverse morgtage. As the borrower receives funds, interest accrues on the outstanding balance of the loan, which can cause the loan balance to grow over time. Additionally, if the home's value decreases, the loan balance may exceed the home's current value.

However, if the loan balance becomes higher than the home's value when the loan is due, the borrower or their heirs cannot be held responsible for the difference. This is because reverse mortgages are non-recourse loans, which means that the lender cannot go after the borrower or their heirs for any amount beyond the value of the home at the time the loan is due. The mortgage insurance premiums that borrowers pay go into a fund that covers lenders' losses when this happens.

Can You Refinance a Reverse Morgtage?

Yes, it is possible to refinance a reverse mortgage. Refinancing allows borrowers to potentially lower their interest rate, change their payment plan, or switch from an adjustable-rate to a fixed-rate loan.

However, the process of refinancing a reverse mortgage is different from refinancing a traditional mortgage. Borrowers must go through a similar application and underwriting process as when they first obtained the reverse mortgage. They will also need to get a new home appraisal, which will determine the home's current value and the amount of equity available.

It's important to note that refinancing a reverse mortgage can come with upfront costs, such as closing costs and appraisal fees. Borrowers should carefully consider the potential benefits and costs of refinancing and consult with a qualified financial professional to determine if it is the right choice for their situation.

The Bottom Line

For senior homeowners, a reverse mortgage can be a useful financial tool. However, borrowers should understand how the loans work and the tradeoffs involved. It is advisable that anyone interested in obtaining a reverse mortgage takes the time to learn about how these loans work. This will prevent unscrupulous lenders or predatory scammers from taking advantage of them, allow them to make a sound decision even with a poor-quality reverse mortgage counselor, and avoid any unpleasant surprises.

Reverse mortgages can be complicated, and borrowers should educate themselves to ensure they are making the best use of their home equity. Additionally, they should shop around for the best reverse mortgage companies rather than choosing the first lender who solicits their business. Rates and fees can vary widely among lenders, as the federal government does not set reverse mortgage rates.
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