What is a Reverse Mortgage?
Reverse mortgages are loans reserved for seniors 62 and older and do not require monthly payments. Borrowers typically repay loans after moving out of the home or passing away. Those 62 and older with substantial home equity can borrow against their home's value and receive a lump sum, fixed monthly payment, or line of credit. Reverse mortgages are not like forward mortgages, used to buy a home.
As a result of federal regulations, lenders have to structure the loan transaction so that the loan amount does not exceed the home's value. The borrower or the borrower's estate is not liable for the difference if the loan balance exceeds the home's value. This could happen due to a drop in the home's value or if the borrower lives for a long time.
- Reverse mortgages are loans offered to older adults 62 and older.
- Homeowners can benefit from reverse mortgage loans by converting their equity into cash income without paying a monthly mortgage payment.
- Most reverse mortgages are federally insured, but be aware of scams that target seniors.
- For some seniors, reverse mortgages are a good financial decision, but they are a poor choice for others. Before deciding, understanding reverse mortgages and their implications for you and your family is essential.
How a Reverse Mortgage Works
The homeowner pays the lender with a reverse mortgage instead of paying the homeowner. We will explain how the homeowner can receive these payments in the next section, and they will only pay interest if they receive proceeds. Due to its bundled nature, interest isn't paid upfront by homeowners. Furthermore, the title remains with the homeowner when a homeowner's loan matures, their debt increases, and the equity in the home decreases.
Reverse mortgages are secured by the home, just like forward mortgages. On the homeowner's passing or move, the reverse mortgage's principal, interest, mortgage insurance, and fees are repaid to the lender. If the sale proceeds exceed the amount borrowed, they are paid to either the homeowner (if still alive) or the homeowner's estate (if deceased). The heirs can keep the home if they pay off the mortgage.
There is no tax on the reverse mortgage proceeds. Although the homeowner may consider the money income, the IRS views it as a loan advance.
Types of Reverse Mortgages
Three different types of reverse mortgages exist. HECMs are the most popular type. Lenders typically offer reverse mortgages under $765,600 as HECMs, the most common type. In the following paragraphs, we will discuss HECMs. However, if your home is worth more than $200,000, you may qualify for jumbo reverse mortgages, also known as proprietary reverse mortgages.
Reverse mortgage proceeds can be received in six ways:
- When your reverse mortgage closes, you receive the total amount at once.
- Borrowers generally make equal monthly payments for a specific period of time, such as ten years.
Credit can be obtained whenever the homeowner needs it. In addition, homeowners don't pay interest on loans. Apart from equal monthly payments, the lender also offers a line of credit to borrowers as long as their home remains their primary residence. The borrower may draw on the line of credit whenever more money is needed.
Term loans and lines of credit:The lender provides the borrower with equal monthly payments for a set period of time. If the borrower needs more funds, the line of credit can be accessed during or after the term.
Could You Benefit from a Reverse Mortgage?
HELOCs and home equity loans may seem similar to reverse mortgages. A reverse mortgage is similar to one of these loans in that it provides you with a lump sum or credit line you can draw from based on how much you have paid off and the value of your home. However, unlike a home equity loan or a HELOC, you don't have good credit or income to qualify for a second mortgage.
Reverse mortgages are only available to seniors whose finances are tight or whose credit is too poor to qualify for a home equity loan.
What If You Don't Qualify?
If you are not eligible for any of these loans, what other options do you have to fund your retirement with home equity? It is possible to continue living in the home by selling and downsizing or selling it to your children or grandchildren. Alternatively, you can become their tenant to continue living in the home.
Pros and Cons of a Reverse Mortgage
A reverse mortgage can be a great solution in situations where your home equity is your biggest asset, and you have no other means to cover your basic living expenses. You don't have to move into a nursing home or assisted living facility when you get a reverse mortgage as long as you pay your property taxes, maintenance, and insurance.
However, the interest and loan fees associated with reverse mortgages require you to spend a significant amount of the equity you have built up. You cannot probably pass on your home to your heirs as well. Reverse mortgages may not be worth the risk when they provide short-term solutions instead of long-term solutions.
What options do you have if you live with a friend, relative, or roommate? The person who gets a reverse mortgage won't live in the home after you pass away.
Borrowers may even outlive their mortgage proceeds. Choosing a payment plan that does not provide a lifetime income, such as a lump sum or term plan, or taking out a credit line and using it all up, may leave you without money when you need it most.
What Are the Requirements for a Reverse Mortgage?
To qualify for a reverse mortgage, you must own a house, condominium, townhouse, or manufactured home built after June 15, 1976. FHA rules prohibit cooperative homeowners from obtaining a reverse mortgage since they do not own the real estate but rather own shares in a corporation. In addition, according to New York state law, reverse mortgages are not allowed in co-ops but only in one- to four-family homes.
Even though reverse mortgages do not require a credit score or income, they still have eligibility requirements. They require that you are at least 62 years of age. The home must be owned free and clear, or the equity must be substantial (at least 50%). Origination fees, up-front mortgage insurance premiums, loan servicing fees, and interest must all be paid by the borrower. The federal government sets a cap on these costs.
Whenever a home is sold, a lender cannot go after borrowers or heirs underwater. Any heirs who wish to repay the reverse mortgage or sell the house to pay off the loan must also be given several months to decide.
Interested reverse mortgage borrowers must attend HUD-approved counseling sessions. A reverse mortgage counseling session usually costs about $125 and takes about 90 minutes to discuss the pros and cons of obtaining one. Reverse mortgages can affect your eligibility for Medicaid Supplemental Security Income (SSI). In addition, you should discuss with your counselor how you will receive the proceeds.
Maintaining a reverse mortgage requires homeowners insurance and paying property taxes. In addition, if you stop living in your house for more than a year, even if it's for medical reasons, you will be required to repay the loan, which is usually accomplished by selling the house.
In addition to legitimate risks associated with reverse mortgages, the elderly can be targeted by scams. Nevertheless, there are still situations in which a widow or widower could lose their home after the death of their spouse.
How Much Can You Borrow with a Reverse Mortgage?
You can borrow a specific amount based on what's known as the initial principal limit. Depending on the lender and payment plan; you can expect to receive reverse mortgage proceeds. The youngest borrower's age determines the HECM loan limit, the interest rate on the loan, and the lesser of your home's appraised value or the FHA maximum claim amount, which as of Jan. 1, 2021, is $822,375.
However, you cannot borrow 100 percent of the value of your home. This is because mortgage premiums and interest must be paid from your home equity. Here are a few other things you should know about how much you can borrow:
- If a borrower is married, the loan proceeds are determined by the younger spouse's age, even if the spouse isn't a borrower. If the youngest borrower is older, the loan proceeds are higher.
- A lower interest rate allows you to borrow more.
- The higher the appraised value of your property, the more money you can borrow.
- The lender will not withhold part of the proceeds you will receive to cover property taxes and homeowners insurance on your behalf if your reverse mortgage financial assessment is vital.
In October 2017, the federal government decreased the initial principal limit, making it more difficult for homeowners, especially younger ones, to qualify for a reverse mortgage. The benefit is that homeowners retain more equity. Because the mortgage insurance fund had nearly doubled its deficit over the past fiscal year, the government lowered the limit as well as changed the insurance premiums. This fund aims to compensate lenders and protect taxpayers from reverse mortgage losses.
When you choose either a lump sum or a line of credit, you cannot borrow the entire initial principal limit in the first year. After that, the amount of money you can borrow depends on whether you are paying off a forward mortgage or not. If you opt for a lump sum, you will only ever get the amount you receive upfront. Choosing the line of credit will increase your credit limit over time, but only if there are unused funds in your account.
Reverse Mortgages, Your Spouse, and Your Heirs
A loan has to be agreed to by both spouses, but neither spouse has to borrow, and this arrangement can cause problems. Couples who live together in a home, but only one spouse is listed as the borrower on a reverse mortgage, are at risk of losing the home if the borrowing spouse passes away first. Typically, reverse mortgages are repaid by selling the house when the borrower dies. Repayment of the mortgage loan may have to be done through other means, such as a costly refinance if the surviving spouse wishes to keep the house.
A couple may be the only borrowers if only one spouse owns the house, perhaps because it was inherited or because its ownership predates the marriage. As long as both spouses hold title and are borrowers on the reverse mortgage, the other spouse can continue to live in the house after the first spouse passes away. If the borrowing spouse moves into an assisted living facility or nursing home for a year or more, the non-borrowing spouse may even lose the property.
Do This to Avoid Foreclosure from a Reverse Mortgage
There is also the possibility of foreclosure with reverse mortgages. Even though the borrower isn't responsible for making any mortgage payments and therefore cannot become delinquent, a reverse mortgage requires the borrower to meet specific requirements. The lender can then foreclose if the borrower has failed to meet these requirements.
Borrowers of reverse mortgages must live in their homes and maintain them. The home won't be worth fair market value at the time of sale if it is in disrepair, and the lender won't be able to recoup the total amount it extended to the borrower. A reverse mortgage borrower must also maintain current property taxes and homeowners insurance. The lender again imposes these requirements to protect its interest in the property. Your local tax authority can seize your house if you don't pay your property taxes. Having no homeowners insurance will result in the lender's collateral being damaged in the event of a house fire.
Is a Reverse Mortgage Expensive?
HECMs (Home Equity Conversion Mortgages), the most common type of reverse mortgage, are associated with several fees and costs. Some are one-time fees, and some are ongoing costs.
Before applying for a reverse mortgage loan, all applicants must undergo counseling from a counselor approved by the Department of Housing and Urban Development (HUD). Counseling costs will vary depending on the lender and the borrower's specific situation. Fees such as origination fees, closing costs, and mortgage insurance premiums are also charged. You'll also have to pay fees to the lender for costs such as sending account statements, distributing loan proceeds, and adhering to loan requirements.
How Does a Reverse Mortgage Work When The Homeowner Passes Away?
Your reverse mortgage loan should be handled after your death by a plan. The family members also need to understand their options for keeping the house and their responsibilities regarding payments. For example, if you have equity in your house and wish to stay in your family after your death, paying back the loan can get complicated.
How Do You Repay a Reverse Mortgage?
Repayment of a reverse mortgage is not required unless you sell the home, reside outside the home for more than a year, or die. The proceeds from the sale can be used to pay off your reverse mortgage. As a result of residing outside of the home, even involuntarily because of medical needs, the reverse mortgage may become due, and you might lose your home. Reverse mortgages are not without risk. When you pass away, your heirs will be responsible for paying off the reverse mortgage using other funds from your estate, their funds, or proceeds from the sale of the home.
Can You Refinance a Reverse Mortgage?
Absolutely. 18 months must have passed since the original reverse mortgage closed to refinance a reverse mortgage. Considering the exceptionally high origination fee and other fees, refinancing a reverse mortgage should only be considered when adding a spouse, adding equity, or lowering the interest rate.