For homeowners in or nearing retirement, often their home is the biggest source of equity available for them. Those who are struggling with limited income may wish to tap into that equity to cover their basic living expenses and healthcare needs without actually selling the home and moving. That is the purpose behind a reverse mortgage.
A reverse mortgage takes the traditional mortgage and turns it around. Rather than the borrower making payments to the lender and building equity in the home, the lender instead makes payments to the borrower against the equity in the home. Over time the equity in the home is utilized as the monthly payments are sent to the borrower and the lender is thus repaid when the home is sold.
Reverse mortgages do not have to be government backed, but the most common type of reverse mortgage known as the Home Equity Conversion Mortgage carries insurance and backing from the Federal Housing Administration (FHA). This provides protections to both borrowers who use these loans and lenders who offer them. This loan can be a great benefit to people who do not have enough in their savings and investments to cover their living expenses in retirement or who face excessive medical costs.
In order to attain a reverse mortgage, a borrower must have his or her name listed on the title and any person named on the home’s title, including the younger spouse, must be 62 years old or older. These loans must be the primary loan on the home, and the home must be the owner’s primary residence.
Borrowers also must pass a financial assessment from the lender that will determine if the borrower has the funds to pay the ongoing expenses, property taxes and homeowners insurance over the life of the loan. The lender will consider pensions, investments, Social Security and other sources of income in this assessment and borrowers will need to have a reasonable credit history or be able to explain any extenuating circumstances connected to any credit problems. While the assessment will typically not lead to a loan denial, it may cause the lender to determine if it is necessary to set aside funds to pay for property taxes and expenses over the loan’s lifetime. The money set aside reduces the monthly payment on the loan but insures money is available for these necessary expenses.
Borrowers who receive reverse mortgages have specific responsibilities they must carry out in order to continue to benefit from a reverse mortgage. Borrowers are required to pay all taxes, insurance and HOA fees connected to the home. Borrowers are also required to keep the home in good condition, performing or hiring service to perform any necessary repairs, so that the value of the property remains intact. If a borrower lives outside of the home for 12 or more months, then the loan is no longer valid. This means extended out-of-town work requirements or extended care situations in a healthcare facility must be discussed with the lender.
A reverse mortgage becomes due when the last surviving borrower passes away or vacates the property. The estate or heirs will repay the loan through sale of the property or by giving the property back to the lender. What is owed will be the lesser of the mortgage balance or 95 percent of the home’s current appraised value. Reverse mortgages are “nonrecourse” loans, which means the lender cannot go after the borrower’s estate or heirs if the home’s value cannot cover what is owed. In other words, the estate can never owe more than the property’s value. If the loan is backed by federal mortgage insurance, the insurance will cover the difference. Any leftover equity goes back into the borrower’s estate to be distributed according to his or her estate plan.
Terms and Limits
Because a reverse mortgage is not designed like a conventional mortgage, it does not have a 30-year or similar term. Instead, the money can be withdrawn as long as the equity balance remains. However, reverse mortgage loans do have limits. Borrowers will be given a limit based on their age, the appraised value of the home, current interest rates and the upfront costs of the loan. Also in the first 12 months after closing, the borrower cannot take more than 60 percent of the approved amount and the only time an amount greater than the 60 percent is allowed is when the money is used to pay down an existing mortgage. In this case, in the first 12 months the borrower can withdraw enough to pay the mortgage and an additional 10 percent of the maximum allowable amount.
Most reverse mortgages charge a mortgage insurance fee. This fee protects the borrower against two potential problems. It protects against the chance that the lender is not able to make a payment as agreed and it protects against the value of the home dropping to the point that it cannot cover the loan balance.
Reverse mortgage costs are typically paid from the proceeds of the loan, rather than being paid out of pocket. These costs reduce the equity in the home and the net loan amount available to the borrower, however they do not require a large upfront payment. These fees include the mortgage insurance premium, third party charges, origination fees, interest and servicing fees. The fees are similar to the mortgage insurance, closing costs and interest on a conventional loan.
Home Equity Conversion Mortgage
The Home Equity Conversion Mortgage, or HECM, is a reverse mortgage regulated through the U.S. Department of Housing and Urban Development (HUD) and is the most common type of reverse mortgage in the United States. This is not a government loan, but it is insured by the Federal Housing Administration, which is a division of HUD. In order to have this mortgage, the borrower must pay an insurance fee of 1.25 percent of the loan balance each year, which is added to the loan. In order to receive an HECM, the borrower must also agree to receive third-party financial counseling.
Tenure HECM Loans
HECM reverse mortgages come in several types. Tenure offers equal monthly payments for the life of the borrowers, as long as they live in the home. This can serve as supplemental income to support retirement lifestyles.
HECM Term Loans
Similar to tenure loans, this loan pays out equal monthly payments, but only for a fixed period of time as requested by the borrower and approved by the lender.
HECM Line of Credit
A line of credit allows the borrower to take out installments when needed and for amounts of the borrower’s choosing until the line of credit is maximized. These payments are not scheduled at regular intervals, but are instead given when requested. Modified tenure and modified term loans combine a line of credit with the scheduled monthly payments to provide greater flexibility.
Proprietary Reverse Mortgage
The Proprietary Reverse Mortgage is rare in current market conditions, but this could change. These loans have fewer regulations than HECMs and are insured through the mortgage companies that offer them. These are typically offered on homes valued at $750,000 or more and may be called “jumbo” reverse mortgages.
Frequently Asked Questions
How can reverse mortgage funds be used?
Most borrowers choose a reverse mortgages when they need money for day-to-day living expenses or excessive medical bills, but the loan does not dictate how the money must be used. Individuals may choose to use the funds for other purposes including large, unexpected expenses like home repairs or medical bills.
Does the borrower have to pay back the loan?
The loan is not paid back, even if all of the principle is paid out in the monthly payments. The borrower does have to remain in the property and stay current with property taxes, insurance and any HOA fees. If the borrower leaves the home, it must be sold to repay the reverse mortgage.
Can I get a reverse mortgage if I already have a mortgage?
The reverse mortgage must be the primary lien on the home. However, if an existing mortgage is in place, the proceeds from the reverse mortgage will pay off that loan before the borrower gets payments from the new loan.
What types of properties qualify for reverse mortgages?
Single-family homes, manufactured homes, two to four unit properties, condos and town homes may qualify for reverse mortgages. Co-ops are not eligible.
Does the program have any medical requirements?
No, a borrower can get a reverse mortgage as long as the financial assessment shows they can maintain with the necessary expenses and the home has sufficient equity. Medical conditions do not factor into the decision.
How does the reverse mortgage affect Social Security and Medicare?
Reverse mortgage proceeds do not affect Medicare and Social Security benefits, but can impact eligibility for Medicaid and Supplemental Security income. Individuals on Medicaid or SSI must use reverse mortgage benefits immediately or they will be counted as an asset and impact eligibility. As long as the money received is used during the same calendar month in which it was received, it does not impact eligibility.