Reverse Mortgage

Reverse Mortgage

A reverse mortgage is a type of mortgage limited to homeowners who are 62 years or older. It enables you to withdraw a portion of the equity from your home, without requiring the monthly payments that are typical of conventional mortgages or home equity loans.


 

What Is A Reverse Mortgage?

Life after retirement can be fulfilling, especially if you own a valuable asset like a house. However, you may not easily convert that physical asset into liquid cash if you need funds for things like repairs, paying taxes, and clearing outstanding mortgage debt.

Moreover, having retired, you may not have sufficient income to qualify for a home equity line of credit or home equity loan. Fortunately, you may qualify for a reverse mortgage, which doesn’t require monthly payments. 

This loan is secured by the residential property that you own. The home equity that you draw down is the market value of your “free of debt” interest in your property. That’s calculated by determining the difference between your home’s fair market value and outstanding debt on the property. This number is called “equity.”

Reverse mortgages may help you enhance your financial security, supplement your retirement fund, pay off homeownership taxes, deal with major expenses like healthcare, or pay for other expenses. You only repay the principal, interest, and fees once you sell the home or move permanently.

How Does a Reverse Mortgage Work?

A reverse mortgage is different from a conventional mortgage, which involves a lender providing funds for you to build or buy a home and then you make monthly payments. In a reverse mortgage, the lender converts part of the equity value in your home into payments to you, and you won’t be required to make monthly payments as long as you live in the house. In other words, a reverse mortgage is much like an advance payment on your home equity.

The loan term of a reverse mortgage is the duration that you remain living in your home after taking out the mortgage. According to Forbes Magazine, the average term is about seven years.

You can receive the money from a reverse mortgage either as a cash lump sum, a line of credit, monthly payments, or some combination of each option. In case you’re still making payments on a conventional mortgage for the home, the reverse mortgage can pay off that mortgage (your traditional mortgage balance gets rolled into the reverse mortgage).

Eventually, you, your spouse, or your estate will repay the reverse mortgage after you die, sell the home, or move out for about 12 months. That may mean selling the home to repay the loan.

The money you get in a reverse mortgage is typically tax-free. The interest is not deductible on your income tax returns until you pay off the loan.

Generally, this loan doesn’t affect your Social Security or Medicare benefits. However, if you’re on Supplemental Security Income (SSI) or Medicaid, it may be wise to immediately use any reverse mortgage proceeds. That’s because funds that you retain may count as assets that can impact eligibility (generally, the maximum amount of countable assets to qualify for Medicaid is $2,000 for individuals and $3,000 for married couples).

Take note that the interest tax deduction on a reverse mortgage may be limited because it’s generally subject to existing limits on home equity debt. As a rule, home equity debt isn’t deductible unless it is used to build, buy, or substantially improve the home.

With a reverse mortgage, you retain the home’s title. This is different from a title loan, which involves a lender holding the title until you repay your loan.

What Are the Different Types of Reverse Mortgages?

Three types of reverse mortgages exist, offering varying benefits and featuring different requirements:

  1. Single-purpose reverse mortgage: As the name suggests, you can only use this loan for one purpose, specified by the lender. For instance, the loan may be used only to pay for improvements, home repairs, or property taxes.

This loan is offered by non-profit organizations, and some state and local government agencies. Compared to the other types of reverse mortgages, this option is typically the least expensive. Most homeowners with moderate or low income can qualify for this loan.

  1. Federally-insured reverse mortgage: Also called a Home Equity Conversion Mortgage (HECM), this reverse mortgage is federally insured and backed by the U.S. Department of Housing and Urban Development (HUD) and the Federal Housing Administration (FHA). Unlike the single-purpose reverse mortgage, HECMs can be used for any purpose.

To be eligible for the HECM, your property must meet all FHA property standards and flood requirements. Eligible properties must be single family homes, 1-4 unit homes with one unit occupied by you (the borrower), FHA approved condominiums, or manufactured homes that meet FHA requirements.

  1. Proprietary reverse mortgages: Proprietary reverse mortgages are offered by private lenders that establish their own terms. These mortgages aren’t federally insured like HECMs. As a result, the loan amount is only limited to the level of risk a lender is willing to take.

The dollar amount you can receive from a proprietary reverse mortgage can be in the millions. That’s why it’s sometimes called a jumbo reverse mortgage, primarily geared towards borrowers whose homes are worth more than an HECM limit.

What are the Requirements of a Reverse Mortgage?

Before applying for a reverse mortgage, it’s important to seek counseling from a FHA-approved reverse mortgage counseling agency that can help you determine if you’re qualified for a loan. Counselors cover topics like eligibility, loan limits, loan amounts, and future repayments.

Generally, potential borrowers must fulfill the following key requirements to qualify for a reverse mortgage:

  • The youngest borrower on the home’s title must be at least 62 years old.
  • You live in the home as your primary residence (basically, that means living in the home more than 6 months out of every year, and it’s in the location where you do your banking, get your mail, etc.).
  • You own the home outright or have sufficient equity (generally, you must be able to pay off your mortgage balance when you close on a reverse mortgage, either using your own funds or the reverse mortgage loan).
  • You meet the minimum residual income requirements set by the FHA, which refers to the amount of money you have remaining after paying all your other obligations. The minimum amount varies based on family size and the region in which you live (due to the varying cost of living, nationwide).
  • You aren’t delinquent on any federal debt like federal student loans or federal income taxes. However, you can use the reverse mortgage loan to pay off this debt.
  • You agree to set aside a portion of the reverse mortgage loan or use your own money to pay ongoing property charges like taxes, insurance, maintenance, and repair costs.

How Much Money can a Reverse Mortgage Provide?

The amount of money you receive from a reverse mortgage depends on multiple factors. One key influencing factor is whether you apply for an HECM or a reverse mortgage from private lenders.

For HECMs, HUD sets a “Maximum Claim Amount” (MCA) or maximum loan amount for each county in the U.S. The absolute maximum amount you can receive with a HECM is $765,600, but private lenders may offer amounts above that limit.

Generally, in federally-insured or private market reverse mortgages, the actual dollar amount you receive depends the following aspects that are used in calculating your loan amount:

  • Equity: You can take out more money if you have more equity in your home.
  • Home value/ loan limit/ home price: For HECMs, lenders consider the lesser of the appraised value of your home, the actual sales price of the home, or the HECM mortgage limit in your area.
  • Interest rate: You can get more if the loan’s current interest rate is low.
  • Age: Lenders consider the age of the youngest borrower on the loan (if there’s more than one borrower) or an eligible non-borrowing spouse.

Generally, you cannot borrow the full Maximum Claim Amount (MCA) in your area. A lender will reduce the available amount by a certain percentage, based on the age of a non-borrowing spouse or the youngest borrower. This initial calculation will produce the maximum Principal Limit (PL).

The final dollar amount that you receive – called the Net Principal Limit (NPL) – will be the PL minus mandatory obligations (includes closing costs, existing mortgage balances, and property charges due at closing), required home repair costs, and possibly a Life Expectancy Set-Aside (LESA). LESA is an amount of your equity that is reserved for paying certain future expenses.

How Do You Receive Payments from Reverse Mortgages?

A reverse mortgage provides several options through which you can receive payments. You may also be able to change the payment options for a small fee.

The available options include:

  • Single disbursement: This payment option is only available with a fixed rate loan, and you’ll likely receive less money compared to other options.
  • Term option: This option involves a specific duration (for example 10 or 20 years) in which you receive fixed monthly cash advances.
  • Tenure option: You’ll receive fixed monthly cash advances for as long as you live in your home.
  • Line of credit: You can draw down the loan proceeds at any time, in whatever amounts you choose, until you use up the line of credit. Here, you owe interest only on the credit that you are using – not the entire loan.
  • Combination of a line of credit and monthly payments: Here, you can combine either a term or tenure option with a line of credit. With a modified term and line of credit, you establish a line of credit and receive fixed monthly payments for a specified duration. With a modified tenure and line of credit, you establish a line of credit and receive fixed monthly payments for as long as you live in your home.

Each payment option has certain key benefits that you may consider when choosing your preferred method.

The unused portion in a line of credit grows over time. This growth is based on the fact that you are getting older (your age is a consideration when calculating the reverse mortgage loan amount) and your home is appreciating in value. This is different from a lump sum option that provides a fixed amount.

With a term option, the dollar amount you receive each month won’t change, even if your home value decreases. Similarly, a tenure option provides you with fixed monthly payments for as long as you live in the home as a primary residence, even if your loan balance exceeds your home’s value.

The single disbursement lump sum option may be useful in paying off an existing mortgage on your property, or for downsizing and purchasing a new home (HECM for Purchase program). 

Using a HECM for Purchase, you can buy a new home outright using a combination of funds from the reverse mortgage, the sale of the old home, savings, gift money, and other income sources.

What are the Costs Associated with Reverse Mortgages?

Similar to other home loans, reverse mortgages come with closing costs, including interest and fees. Keep in mind that reverse mortgages tend to have higher interest rates compared to traditional home loans. However, the rates vary depending on the lender, your creditworthiness, your home value, and other factors.

The closing costs are often built into your loan. That means the lender lets you finance closing costs into your loan, so you don’t have to pay out-of-pocket.

HUD details the following HECM fees and charges:

  1. Mortgage Insurance Premium (MIP): Lenders charge a 2% initial MIP at closing, and an annual MIP, which is 0.5% of your outstanding loan balance.
  2. Origination fee: The FHA caps origination fees at $6,000. Lenders charge either $2,500 or 2% of the first $200,000 of your home’s value, whichever is greater. Any amount over $200,000 is charged 1%.
  3. Servicing fee: Lenders may charge a monthly fee for the life of the loan to monitor and maintain it. The FHA caps monthly servicing fees at $30 for fixed or annually-adjusting rate loans, or $35 for monthly adjusting rate loans.
  4. Third-party charges: Third parties charge various fees including appraisal, inspections, title search and insurance, mortgage taxes, and recording fees.

Your reverse mortgage interest can be a fixed rate, or a rate that adjusts monthly or annually. The FHA doesn’t place any limits on the changes of monthly-adjusting rates. However, annually adjusted rates are limited to adjust by a maximum of 2% per year and 5% over the life of the loan.

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References
  1. https://www.hud.gov/program_offices/housing/sfh/hecm/hecmabou
  2. https://www.reversemortgage.org/about/hecm-payment-options/
  3. https://www.consumer.ftc.gov/articles/0192-reverse-mortgages
  4. https://www.hsh.com/reverse-mortgage/reverse-mortgage-borrowing-limits.html
  5. https://www.benefits.gov/benefit/709
  6. https://reverse.org/reverse-mortgage-eligibility/
  7. https://www.hudexchange.info/programs/housing-counseling/hecm/
  8. https://longtermcare.acl.gov/medicare-medicaid-more/medicaid/medicaid-eligibility/financial-requirements-assets.html
  9. https://www.irs.gov/faqs/other/for-senior-taxpayers/for-senior-taxpayers
  10. https://homeguides.sfgate.com/normal-term-reverse-mortgage-years-62796.html
  11. https://www.bankrate.com/mortgages/reverse-mortgage-guide/