Reverse mortgages are so-called because they reverse the way mortgages traditionally work. Instead of making payments to the mortgage company, the lender makes payments to you. And while receiving monthly payments is an option, you can also take all of your cash in a lump sum, similar to a cash-out refinance. You can also take the loan as a home equity line, allowing you to access it whenever you need it.
Due to how a reverse mortgage works, they are only available to seniors.
The obligation of the homeowner to pay back their mortgage is deferred until the owner dies, sells the home, or moves to a nursing home or assisted living facility. Reverse mortgage lending limits are $625,500, regardless of how much the home is worth, and the maximum amount that can be charged for a loan origination fee is $6,000.
An Introduction to Reverse Mortgages
If you pay attention to those commercials, reverse mortgages are the answer to all of your problems, but as you know, you can’t believe everything you hear on TV.
Here is what you can expect from a reverse mortgage—the good, the bad, and the ugly:
Who Qualifies for a Reverse Mortgage?
Qualifications for a reverse mortgage include:
- Be 62 years of age or older (both borrowers)
- Own the property outright or have paid down a considerable amount
- Occupy the property as your principal residence
- Not be delinquent on any federal debt
- Have financial resources to continue to make timely payments of ongoing property charges such as property taxes, insurance, Homeowner Association fees, etc.
- Participate in a consumer information session given by a HUD-approved HECM counselor.
In the United States, only borrowers who are 62 years or older qualify for reverse mortgages. Unlike other mortgage products, it doesn’t matter which credit score range you are in, and there are no credit or minimum income requirements.
You must own and live in your home and have equity in it, although your mortgage is not required to be completely paid off. However, the lender will want to see that you have substantial equity in your home before agreeing to a reverse mortgage.
If you have an existing mortgage when you apply for a reverse mortgage, you must pay it off with proceeds from a reverse mortgage. Not all homes will qualify for a reverse mortgage. Mobile homes qualify if they meet certain criteria, like having a permanent foundation and being built after 1976.
Third-Party Financial Counseling is Required to Obtain a Reverse Mortgage
If you are applying for a reverse mortgage, you’re going to have to go through several steps to secure your loan.
The first step is attending a financial counseling meeting with a counselor approved by the Department of Housing and Urban Development (HUD). They can help you decide if one of these loans is right for you and will walk you through the application process.
During the counseling, borrowers will learn exactly what a reverse mortgage is and how to obtain one before proceeding with the process. The counseling sessions cost around $125, although there are federal agencies that provide grants to enable people to attend counseling for free.
At this point, you’ll have to go through a financial assessment in order to qualify.
How a Reverse Mortgage Works
Unlike a traditional loan, you are not required to pay back the amount of the loan in monthly installments. Instead, the loan plus interest will be due when you sell the house, pass away, and can no longer consider the home your primary residence or at the end of the agreed-upon loan period.
If you become incapacitated and must stay in a nursing home for a period of time, you have 12 months before the home is no longer considered your primary residence—that is, 12 months before the loan is due.
You can receive the payout from the reverse mortgage in one of five ways. With tenure payments, you will receive monthly payments for as long as at least one borrower still lives in the house. Term payments are monthly checks that will arrive for a fixed period.
A line of credit gives you the opportunity to draw unscheduled payments when you need them in the amount you need them until the credit limit is reached. Modified tenure and modified term payments combine monthly payments with the line of credit option.
Most reverse mortgage payments are tax-free. However, you are still responsible for your home’s property taxes, plus homeowners insurance and whatever maintenance your house requires.
How Much Can I Borrow with a Reverse Mortgage?
The maximum loan amount is $625,500, but your loan amount will be calculated based on the appraised value of your home multiplied by a percentage. That percentage will be based on a combination of factors, including your age and the interest rate on the loan. But it will always be some percentage considerably lower than 100% of the property value. However, the older you are, the higher the percentage of the property value that can be taken in the loan.
Everyone should be aware of one important feature of reverse mortgages before applying for one. Since you are not making monthly payments on the loan, the interest on the loan will be added to the principal each month. Unlike a traditional mortgage, where you make your monthly payment that includes both interest on the loan and at least a small reduction in the principal balance, with a reverse mortgage, the loan amount increases the longer it is outstanding.
This is also why loan amounts are larger the older you are when applying. Since an older applicant is not expected to live as long as a younger one, the interest accumulation is expected to be smaller. This allows a loan to an older person to be higher, sometimes much higher, than for a younger borrower.
When Does a Reverse Mortgage Need to Be Paid Off?
The loan is due when the last borrower dies or when the borrowers move out of the property into a new primary residence. At that point, the mortgage has to be refinanced or paid off. Otherwise, the lender can foreclose on the property. Fortunately, if the house sells for less than the amount of the loan owed, neither the borrower nor the borrower’s estate will be required to pay the difference.
Reverse Mortgage Fine Print:
Not everything about reverse mortgages is good news, and it’s very important to enter into a reverse mortgage with your eyes open.
You or your heirs will have to repay the loan plus interest at the end of the loan term.
The annual percentage rate you pay can be either fixed or variable, just like in a traditional loan or mortgage. Also, the reverse mortgage may use up all of the equity you have in your home, meaning that there will be nothing left of your equity after the sale of your home.
In addition, the amount of money you are eligible to borrow against your home is dependent on several factors, including the age of the youngest borrower, the interest rate, and the appraised value of your house. So even if your home is worth quite a bit, you cannot necessarily count on it being your golden goose.
For example, if all of the factors are the exact same, an 80-year-old applicant is going to be able to borrow more money through a reverse mortgage compared to what a 62-year-old would be able to get.
Reverse Mortgages Often Come with High Fees
As with everything in life, there are going to be some fees that come along with reverse mortgages. Many of these fees are the same fees you pay with a traditional mortgage. There are three types of fees you’re going to pay:
- Origination fee
- Third-party fees
- Mortgage insurance premiums
The origination fee is paid to the lender, and they are regulated by the government.
These fees can range anywhere from $2,500 to $6,000, and it’s based on how much your property is worth. The fee is 2% of the first $200,000 value of the property and then 1% of the value above the $200,000.
The next part is any third-party fees. This could be anything from title fees to inspections. The price of these is going to vary from company to company.
The mortgage insurance premiums are the last portion. The mortgage insurance is the protection the FHA gives to all of its borrowers. This fee is going to be 2% of the property value.
The biggest concern about a reverse mortgage is why you might need it.
If you are coming to a reverse mortgage because you have not been proactive with your finances and retirement savings, then you want to make sure you educate yourself on how to handle the details. You don’t want your lack of planning to create a mess for yourself or your heirs should money continue to be a problem.
However, as long as you enter into a reverse mortgage with a plan and open communication between yourself, your lender, and your family, it can be a positive tool for supplementing your retirement.
Pros and Cons of Reverse Mortgages
Advantages of Reverse Mortgages
Many people automatically assume a reverse mortgage seems “too good to be true,” but in the right circumstances, a reverse mortgage creates a valuable financial resource for individuals during their retirement.
Reverse mortgages have become very popular, and it’s easy to see why.
It’s a way to get cash that doesn’t require a monthly payment. As mentioned above, with a reverse mortgage, the lender pays you monthly rather than you having to make a monthly payment. It’s one of the few ways available to anyone to borrow money without having a monthly payment.
You don’t need to qualify based on income and credit. Since there is no monthly payment, there is no monthly payment to qualify for. That means income is not a factor. It is presumed that obtaining an additional income is your primary reason for applying for the mortgage.
It works best for the oldest borrowers. The older that you are, the better the reverse mortgage works. A reverse mortgage is set up something like an insurance policy – it largely rests on your life expectancy. The shorter your life expectancy, the larger the loan you will be granted. This is a built-in factor with reverse mortgages, since the loans accumulate more interest the longer that they are outstanding.
It can provide a retiree with a much-needed income supplement. In a time when retirees are earning very little in the way of interest income on their savings, a monthly check from a reverse mortgage could be an important income supplement.
It may be the only way a senior can stay in their home. For many senior homeowners, short on both cash and income, a reverse mortgage is a way to stay in their home without increasing their monthly obligations.
Additional benefits and advantages of a reverse mortgage include:
- No default. Whereas you can lose your home if you fail to make payments on a home equity loan, reverse home mortgage lenders do not have a claim over your assets or income.
- Cannot be “upside down.” You will never owe more than the value of your home, even if the price of the home declines after you secure a reverse mortgage.
- Use the money how you want. There are no restrictions on what you use money from a reverse mortgage for. You can use it to travel, purchase long-term care insurance, pay for your children or grandchildren’s educational expenses, get a new car – anything goes.
- Tax-free money. When a homeowner receives money from a reverse mortgage, it’s actually a loan. So the money is not taxable.
- Choose how you get the money. You can receive money from a reverse mortgage in a single lump sum, a credit line, annuity, or a combination of payment options.
- Remain a homeowner. You remain the homeowner and have the ability to stay in your home with a reverse mortgage – for as long as you want.
Disadvantages of Reverse Mortgages
Like everything in life, there are also disadvantages involved with reverse mortgages.
Equity stripping. Whatever the apparent benefits of a reverse mortgage, it is, in essence, a cash-out refinance. Any time a home is refinanced and the cash is used for a purpose other than the home itself, the refinance is a form of equity stripping. In general, equity stripping is not a good strategy, especially when you consider that one of the fundamental goals of retirement planning should be to own your home free and clear.
You will probably get more money selling the house. Reverse mortgages are limited by various factors, including your age and property value. If you need all the cash you can get for survival purposes, you’ll get more by selling your home rather than taking a reverse mortgage.
What do you do when your equity is all gone and you still need money? Let’s say that you are 75 years old and take a reverse mortgage for $130,000 – the maximum you are allowed under the program. But five years later you’re 80 years old, and the cash is all gone. What will you do next to get the cash you need to survive for the rest of your life?
Leaving less for your heirs. If your home is your primary asset and most of what you hope to leave to your heirs following your death – and it probably is if you are considering a reverse mortgage – a reverse mortgage will substantially reduce the size of your estate, and how much will be left for your heirs.
You will have to pay mortgage insurance. The upfront mortgage insurance premium (MIP) will be between .50% and 2.50% of your loan amount, and will be paid at closing. You will then pay an annual MIP equal to 1.25% of the mortgage balance. The MIP in both forms is insurance the federal government collects to insure your loan against default. This will be in addition to your property tax, homeowner’s insurance, and utility and property maintenance costs.
Loan closing costs. Just as you would have closing costs when taking a new mortgage, you’ll also have them with a reverse mortgage. Program regulations cap them out at $6,000, but that’s still a good chunk of money.
The following circumstances may render a reverse mortgage a poor choice for you:
- Eligible for low-income assistance. If you receive low-income assistance from the government (such as Medicaid) keep in mind that getting a reverse mortgage may disqualify you from receiving the benefits.
- Planning to move soon. If you decide to move from your primary residence, you owe the reverse home mortgage loan back to the lender. If you plan to move in a short period of time after obtaining a reverse mortgage, it’s not in your best interest to get one. Closing costs on reverse mortgages are higher than on conventional mortgages, and this will be a costly move.
- Leaving the house to heirs. If you intend to leave your home to your heirs, a reverse mortgage may not be a good option. It decreases equity in your home and affects the value of the estate. If you do a reverse mortgage, you can still bequeath the home to heirs who can choose to refinance, pay off the mortgage, or sell the home.
Reverse Mortgages Can Be Useful
Your retirement can be an excellent and fun time of life, but it can also be stressful and taxing. Many retirees get a couple of years into their retirement and realize they don’t have enough saved up to get them through.
This is where reverse mortgages can be a useful tool.
But they aren’t for everyone. If you qualify for a reverse mortgage and find yourself needing income, then a reverse mortgage may be a good way to tap into your home equity. Just keep in mind the situations in which a reverse mortgage is due: when the owner dies, sells the home, or moves to a nursing home or assisted living facility.
When you’re making a big financial decision like taking on a reverse mortgage loan, you must have all the information you need to make a wise decision for yourself and your loved ones.
Hopefully, this has given you a quick insight into the ins and outs of reverse mortgages and can give you the resources you need to conquer a reverse mortgage and reach your retirement dreams without having to pick up a job delivering pizzas.