Almost everyone has heard of a reverse mortgage, but few people really understand how a reverse mortgage works or if it is right for them.
A Reverse Mortgage Review
A reverse mortgage is a loan paid to someone who owns their home or has enough equity built up in their home where they can borrow money during retirement. Reverse loans can be paid in several ways:
- A single lump sum
- As a regular monthly payment
- At different times and for different amounts
Reverse mortgages must be paid by following the death of the last borrower or spouse of a borrower, or if the borrower moves and sells the home.
The Types of Reverse Mortgages
There are 2 different types of reverse mortgages: Public sector and private sectors.
- Public sector reverse mortgages are available through state and local government and are usually reserved for people who have limited incomes and need to make repairs or improvements to their homes or pay property taxes.
- Private sector reverse mortgages are available from banks, mortgage lenders, and savings associates. The money received through a private sector reverse mortgage can be used for any purpose.
Home Equity Conversion Mortgages
Home equity conversion mortgages (HECMs) are the most common type of reverse mortgage. These private sector reverse mortgages are insured by the Federal Housing Administration (FHA). The FHA, which is part of the U.S. Department of Housing and Urban Development (HUD), tells HECM lenders the amount they can lend, based on the age of a homeowner and the value of the home. The FHA also guarantees that HECM lenders meet certain obligations under the loan, and insures lenders against loss if reverse mortgage payments exceed the equity in the home when the home is eventually sold.
There are several advantages and requirements for an HECM reverse mortgage:
- The proceeds may be used for any purpose
- There is considerable flexibility in how the funds are paid out to the borrower
- HECMs are widely available
- They are the least expensive reverse mortgage that can be used for any purpose
Since HECM reverse mortgages are backed by the FHA, there are a number of requirements that have to be met in order to qualify:
- The borrowing spouse must be at least 62 years old
- The home must be occupied as the primary residence
- The home must be owned outright or have a considerable amount of equity
- The home must be a single-family residence, with specific rules falling under FHA guidelines
- There must not be any delinquent federal debt
- There must be sufficient income to pay for property taxes, insurance, and upkeep of the home
- Income, assets, monthly living expenses, and credit history must be verified
- Proof of paid real estate taxes, hazard and flood insurance premiums
- The property must meet FHA minimum property standards
- The homeowners must receive free HUD-approved reverse mortgage counseling
HECM Loan Amounts and Payment Options
Once approved for a HECM reverse mortgage, the loan amount will be determined based on age, home value, current interest rates, and the mortgage insurance premium option selected.
- Age – The older a person is, the larger the reverse mortgage amount will be. For a spouse, the age of the youngest borrowing and non-borrowing spouse is used.
- Home Value – The amount allowed to borrow is the lesser of the appraised value or the HECM FHA mortgage limit or the sales price, whichever one is the least.
- Interest Rate – The lower the interest rate, the higher the amount of money available to loan.
- HECM Costs – Most of the costs of a HECM can be financed in the loan. If most of the costs, such as the mortgage insurance premium, closing costs, or any other fees associated with the closing. However, the more of the fees that are financed, the les the net loan amount available to borrow will be to the home owner.
Payment options vary depending on how the loan is structured. Payment can be received as:
- A single lump sum
- A line of credit
- A tenure plan
- A term plan
- A modified tenure plan
- A modified term plan
Homeowners who choose the lump sum payment option are restricted to 60% of the value of the value of the loan the first year.
HECM Loan Repayment
Any HECM reverse mortgage loan must be repaid when:
- The last surviving borrower or non-borrowing spouse passes away or sells the home.
- The home is sold.
- The home is allowed to deteriorate and the problem persists.
- Property taxes and/or insurance is not paid.
- All borrowers and a surviving non-borrowing spouse moves to a new principal residence permanently.
- The last surviving borrowing or non-borrowing spouse fails to live in thehoe for 12 straight months due to physical or mental illness.
There are several costs associated with HECM reverse mortgage loans. Origination fees, closing costs, and mortgage insurance premiums may be paid from the proceeds of the reverse mortgage. This option reduces the amount that a borrower will receive, but it also reduces any upfront out-of-pocket costs.
- Origination Fee – This fee is charged to compensate the lender for processing an HECM loan. The lender can charge either $2,500 or 2% of the first $200,000 of the home’s value, plus and additional 1% of the amount over $200,000. These fees are capped at $6,000.
- Closing Costs – Appraisal, title search, survey, recording fees, and other closing costs vary from area to area, but are counted in the closing cost amount.
- Mortgage Insurance Premium (MIP) – A mortgage insurance premium pays for the guarantee that the borrower will receive the reverse mortgage payments for as long as they live in the home. It also pertains to the assurance that the total payment due when the home is sold cannot exceed the value of the home. MIPs may be financed as part of the loan. An MIP of 2.5% of the appraised value of the property are charged to borrowers who take out more than 60% of the total amount of the loan. Borrower who take out less than 60% will incur an MIP of 0.5% of the appraised value of the property.
With the complexity of reverse mortgages, it is wise to consult with a qualified financial planner before making any major decisions and to gain clarity on your exact financial situation.