With traditional mortgages, when a borrower makes a mortgage payment, a portion of that payment goes to pay interest charges on the current loan balance and the remaining portion of the payment reduces principal loan balance. In other words, when a monthly payment is made on a traditional mortgage, the loan balance is decreased and the borrower’s equity in the home is increased by the exact same amount.
With a reverse mortgage, the borrower does not have any obligation to pay back the lender as long as the borrower resides in the property. This gives the homeowner an opportunity to turn a portion of his/her equity into cash. This can occur in one of the following ways or in a combination thereof:
1. In a single lump sum at the closing of the mortgage;
2. As a predetermined monthly cash advance;
3. As an equity line of credit (more frequently referred to as a credit line in the context of a reverse mortgage), allowing the borrower to decide how much and when distributions are made.
More often than not, reverse mortgages pay out with a large initial sum disbursed followed by either a predetermined monthly advance or an equity line.
Typically, to be eligible for a reverse mortgage, you must own your home and be 62 years of age or older. If you have a spouse that is also on the title to the home, the spouse must be at least 62 years old as well. Owning your home does not mean it has to be free and clear of any debt. Since reverse mortgages generally must be a first loan, any currently existing loans on the home would have to be paid off before or at the time a reverse mortgage is recorded. This normally does not create a problem since the borrower can take an initial cash draw from their reverse mortgage at time of closing to pay off their existing mortgage.
Unlike traditional mortgages, which require a borrower to “qualify” for a loan, a reverse mortgage does not require the borrower to submit income or credit documentation to the lender. This is because the borrower will not be required to make any payments to the lender during his/her lifetime. However, like traditional mortgage lenders, reverse mortgage lenders require that the property “qualify”. Qualification is determined through a property appraisal report. In cases where the property is in the state of disrepair, the lender may require that the property be improved. This can be done with an initial cash draw.
Reverse mortgages become due and payable if the property is sold, if the home is permanently vacated by the borrowers (typically for 12 consecutive months) or when the last surviving borrower dies. Although the lender can require repayment at any time if property taxes become delinquent, property insurance is not paid or the property is not being maintained, it is unlikely to happen if you have available loan funds to cover these items. It is quite likely that the lender would advance funds for these obligations rather than calling the loan.
When the reverse mortgage is finally repaid, the amount owed includes the following:
- all advances made by the lender during the life of the loan, including
- initial cash advance
- monthly cash payments
- lender advances, if any, for taxes, insurance or repairs;
- all loan costs incurred and not paid at closing;
- deferred interest on all items covered in 1 and 2 above.
If the amount owed is less than the value of the home, the balance belongs to the borrower or their estate. On the other hand, if this amount exceeds the value of the home, the borrower or borrower’s estate will never be obligated to pay more than the value of the home.
Generally, the largest loan amounts are available from the Home Equity Conversion Mortgage (HECM). This is the only reverse mortgage that is insured by the federal government. It is insured by the Federal Housing Administration (FHA), which is part of the much larger U.S. Department of Housing and Urban Development (HUD). Because of this, the FHA dictates to approved lenders how much they can lend on a reverse mortgage. Some specific factors that influence the maximum loan amounts are:
1. The age of the youngest borrower: Typically, the younger the borrower the lower the loan amount;
2. The current interest rate environment: Typically, the lower the interest rate the larger the loan amount;
3. The appraised value of the property: Typically, the higher the appraised value the larger the loan amount;
4. The county in which the property is located: These annually reviewed limits were determined in 2004 as part of the National
Housing Act, which established loan limits by county ranging from a low of $160,176 to a high of $290,319.
The following table assumes a home’s value of $250,000 and helps illustrate the impact of borrower’s age and borrower’s current interest rate on loan amount:
Once the loan amount is established, the borrower must make a choice as to how and when funds will be advanced. If part of the funds will be distributed monthly, the borrower has yet another choice to make. That is, a borrower can request a fixed monthly payment for a fixed period of time; say, 5, 10 or 15 years, or a fixed payment for the remainder of the borrower’s life. As you might expect, if a shorter time period is selected, the monthly payment would naturally be larger than if a longer term period was selected. If a fixed period is selected, payments stop after the end of the period. However, the loan does not have to be repaid until the last surviving borrower dies or the property is sold.
While the HECM loans are among the least costly reverse mortgage loans, they are not inexpensive by any stretch of the imagination. A borrower can expect to pay fees comparable to a traditional mortgage, including up to a 2% loan origination fee, a 2% upfront Mortgage Insurance Premium (MIP) fee as well as a .5% increase to the interest rate for MIP. These MIP costs ensure that a borrower will not have to repay the loan as long as they reside in the property, regardless of what happens to the value of the property. Additionally, the MIP insures that the borrower or the borrower’s estate will never have a debt obligation larger than the value of the property.
Reverse mortgages other than the HECM loans are known as Proprietary Reverse Mortgages and are offered by some banks, mortgage companies and private lenders. These tend to be very costly and are more common in areas of the country where home values significantly exceed the loan amount guidelines established by FHA.
Before making a final decision on a reverse mortgage, we caution borrowers and their families to compare reverse mortgage options between lenders and also to explore other options such as:
1. Selling their home and purchasing a less expensive home.
2. Selling their home and moving into a shared rental property.
3. Selling their home and moving into an assisted living facility.
4. Developing a financial plan through a family member that produces benefits for the borrower as well as the family member.
5. Working within the guidelines of the traditional mortgage lenders to develop a mortgage scenario that satisfies the borrower’s needs in a much more competitive way.
Preferred Financial strongly recommends that if you have any further interest in pursuing a reverse mortgage, please visit the AARP website http://www.aarp.org/revmort or call the AARP Foundation at 1-800-209-8085 and request their free publication “Home Made Money: A Consumer’s Guide To Reverse Mortgages”…You’ll be happy you did.