As I grow older, my clientele appears to be getting older too. On several occasions I have been ask about reverse mortgages. Some folks want to know if they should use them to supplement their retirement income. While time and space will not allow me to write about all the ins and outs of a reverse mortgage, I’ll hit upon some major points. Let’s start by defining a reverse mortgage.
A reverse mortgage or home equity conversion mortgage (HECM), is a loan for senior homeowners that uses the home’s equity as collateral. The loan generally does not have to be repaid until the last surviving homeowner permanently moves out of the property or passes away. At that time, the estate has approximately 6 months to repay the balance of the reverse mortgage or sell the home to pay off the balance. Any remaining equity is inherited by the estate. The estate is not personally liable if the home sells for less than the balance of the reverse mortgage.
To be eligible for a HECM reverse mortgage, the Federal Housing Administration (FHA) requires that all homeowners be at least age 62. The home must be owned free and clear or all existing liens must be satisfied with proceeds from the reverse mortgage. If there is an existing mortgage balance, it can be paid off completely with the proceeds of the reverse mortgage loan at closing. Generally there are no credit score requirements for a reverse mortgage.
Generally speaking, a reverse mortgage loan cannot be outlived and will not become due, as long as at least one homeowner lives in the home as their primary residence, continues to pay required property taxes and homeowners insurance and maintains the home in accordance with FHA requirements.
In the event of death or in the event that the home ceases to be the primary residence for more than 12 months, the homeowner’s estate can choose to repay the reverse mortgage loan or put the home up for sale.
If the equity in the home is higher than the balance of the loan when the home is sold to repay the loan, the remaining equity belongs to the estate.
If the sale of the home is not enough to pay off the reverse mortgage, the lender must take a loss and request reimbursement from the FHA. No other assets are affected by a reverse mortgage. For example, investments, second homes, cars, and other valuable possessions cannot be taken from the estate to pay off the reverse mortgage.
The amount that is available generally depends on four factors: age (older is better), current interest rate, appraised value of the home and government imposed lending limits.
There are several ways to receive the proceeds from a reverse mortgage.
- Lump sum – a lump sum of cash at closing.
- Tenure – equal monthly payments as long as the homeowner lives in the home.
- Term – equal monthly payments for a fixed number of years.
- Line of Credit – draw any amount at any time until the line of credit is exhausted.
- Any combination of those listed above
Generally a home equity loan, a second mortgage, or a home equity line of credit (HELOC) have strict requirements for income and creditworthiness. Also, with other traditional loans the homeowner must still make monthly payments to repay the loans. A reverse mortgage generally has no credit score requirements and instead of making monthly mortgage payments, the homeowner receives cash from the lender.
With a reverse mortgage the amount that can be borrowed is determined by an FHA formula that considers age, the current interest rate, and the appraised value of the home. Typically, the more valuable the home, the higher the loan amount will be, subject to lending limits.
The key differences, with traditional loans the homeowner is still required to make monthly payments, but with a reverse mortgage the loan is typically not due as long as the homeowner lives in the home as their primary residence and continues to meet all loan obligations. With a reverse mortgage no monthly mortgage payments are required, however the homeowner is still responsible for property taxes, insurance, and maintenance.
Reverse mortgages have been criticized for several major shortcomings:
- High up-front costs make reverse mortgages expensive. Entering into a reverse mortgage will cost approximately the same as a traditional FHA mortgage.
- The interest rate on a reverse mortgage may be higher than on a conventional mortgage.
- Interest compounds over the life of a reverse mortgage, which means that “the mortgage can quickly balloon”. Since no monthly payments are made by the borrower on a reverse mortgage, the interest that accrues is treated as a loan advance. Each month, interest is calculated not only on the principal amount received by the borrower but on the interest previously assessed to the loan. Because of this compound interest, as a reverse mortgage’s length grows, it becomes more likely to deplete the entire equity of the property.
- Reverse mortgages can be confusing; many obtain them without fully understanding the terms and conditions, and it has been suggested that some lenders have sought to take advantage of this.
Is a reverse mortgage right for you? As already stated, it can be a complicated and confusing process. I believe it is best to have your real estate attorney advise you. In the meantime, if you are thinking about selling your home, give us a call and let’s discuss it together.