Reverse mortgages allow homeowners 62 and older to extract home equity without selling their houses. Reverse mortgage issuers pay cash to owners in lump sums or over time. You do not need to pay back a reverse mortgage as long as you remain in your home and keep up with taxes, insurance, maintenance and repairs to protect the homes’ value.
However, when you permanently move from the home or die, the loan comes due. If your heirs want to keep the home, they must pay the mortgage company what was advanced, plus interest and the FHA Mortgage Insurance Premium. Otherwise, they must turn the property back to the lender.
There are four types of reverse mortgages
- Home Equity Conversion Mortgage (HECM)
- Home Equity Conversion Mortgages for Purchase
- Proprietary Reverse Mortgages
- Single-Purpose Reverse Mortgages.
If you find the idea of a reverse mortgage appealing, understanding exactly how the loan works and what is required of the property owner is critical. You should consider each of the four types before deciding whether one works for you.
Home Equity Conversion Mortgages
Home Equity Conversion Mortgages (HECMs) are the most common reverse home loans. These federally insured loans allow borrowers who meet age and home-equity requirements to pull money out of their residences – the higher the property value, the larger the payment can be.
Unlike a conventional 15-or-30-year mortgage, there are generally no income requirements for qualifying for a HECM.
Money derived from a HECM can be used for any purpose.
The amount you can borrow depends on several factors, including:
- Age of the youngest borrower
- Your home’s appraised value
- Interest rates when you get the HECM
- An assessment of your ability to pay homeowner’s insurance, property taxes, flood insurance, maintenance and other costs.
You should remember that, as with conventional mortgages, reverse mortgages come in different flavors. Before applying for a HECM, you are required to meet with a counselor from the independent government-approved housing agency to review the options. The counselor will review not only the terms of mortgages you’re considering but will discuss other government and nonprofit agency programs that might achieve your goals.
The counselor should discuss the costs associated with each reverse mortgage program, discussing the payment options, fees and other costs that might impact the cost of the loan over time. The Department of Housing and Urban Development keeps a list of approved counselors, who charge a fee of about $125. If you can’t afford the fee, you are still entitled to the counseling.
Cost is a key consideration. Reverse mortgages often come with loan closing costs that are considerably greater than conventional home loans. Before deciding to pursue a HECM, consider how long you plan to stay in you home and how much equity you really need to tap. You should consider those factors in relation to the closing costs before proceeding.
If you decide you still want a HECM, focus on the terms and conditions. According to HUD, the lender may set aside a portion of the principal limit to pay property taxes, special assessments, hazard and flood insurance premiums.
These are the various options on how you will receive payments:
- A single disbursement
- Monthly cash advances over a set period
- Fixed monthly cash advances for as long as you own the home
- A line of credit on which you can draw when you need the money. This limits the interest charged on the loan since you control how much money you borrow against equity
- A combination of a credit line and monthly payments
Like conventional home mortgages, HECMs come with fixed and variable interest rates. This is the interest due on the money disbursed to the homeowner over the course of the loan.
Adjustable rate loans apply to lump-sum, line of credit and monthly disbursal loans and are tied to a funds index such as the London Interbank Offer Rate (LIBOR). As the interest rate changes, an adjustment is either made to the monthly disbursement amount or the borrower can specify a fixed disbursement to the lender based on available funds. With a line of credit, the total size of the credit line can increase if the interest rate decreases. The credit line can’t be cancelled or reduced.
Fixed rate options only apply to lump sum payments.
You should also become familiar with rules and limitations placed on HECM, though they vary. For instance, HECMs often limit how much money you can receive in the first year of the loan. Also, reverse loans require that you live in the mortgaged dwelling as a primary residence.
If you leave the home to enter a nursing home or other long-term care facility and are gone for more than a year, the reverse loan usually must be repaid. Repayment often is also required if you live somewhere else for whatever reason during more than half the year.
Example of HECM
If you are 62 or older, have at least 50% equity in your home , but need money to make ends meet in the retirement years, a HECM reverse mortgage is something to consider.
Qualified individuals or married couples can expect to receive between 40% and 60% of the value of their home through a HECM. The 40% number generally applies to people who are closer to 62 and people in their 80s are more likely to qualify for the 60% figure.
So, if you are 62 and own a home free and clear that is worth $100,000, that means you likely would qualify to receive $40,000 in a HECM.
If you still owe $25,000 on your home, that $40,000 would pay off the mortgage balance and leave you $15,000 to get rid of other bills like credit card debt. Plus, you would no longer have any mortgage payments to make so there is another $400-$500 a month added to your budget.
“Everything in retirement is about cash flow,” said Tim Linger, president and founder of the HECM Association, a trade group in Florida that offers education to seniors on reverse mortgages. “Eliminating a monthly mortgage payment is huge in retirement. It gives you liquidity.”
There is some sobering done when you leave the home because of death or moving to another location. The $40,000 you received is a loan and in 2018, the fixed interest rate on that loan was between 4.5% and 5%. Variable rates were slightly lower.
If you live in the home another 10 years and got a 5% interest, you would owe $65,880 on the $40,000 reverse mortgage. If the value of your home appreciated and sold for $120,000 in that time, your estate would still have $54,120 left after settling the $65,880 balance.
If you live 20 years, the balance on the $40,000 loan would grow to $108,505 and, in the same situation, leave your estate just $11,495.
HECMs for Purchase
A HECM for Purchase is a FHA program that allows people 62 and older to purchase a new home using loan proceeds from a reverse mortgage. It typically requires a large down payment – somewhere between 40% and 55% of the purchase price – and was designed to help seniors relocate or downsize.
HECMs for Purchase are popular with older people who want to move to a less expensive home, perhaps in a warmer place or to be closer to a loved one or find a home that meets physical limitations.
The HECM for Purchase allows you to own a home without making monthly mortgage payments.
Using the program, you buy a new home, make a substantial down payment and take out a reverse mortgage to cover that balance of the purchase price. The size of the down payment is pre-determined by a formula that includes the person’s age (youngest person, if a married couple), the value of the home and the interest rate for the loan.
Since buying the house and acquiring a reverse mortgage are part of a single transaction, you only pay one set of closing costs. If you were to buy the home first, then seek a reverse mortgage, you would have to pay two sets of costs.
“It’s another form of a mortgage, only with this one, no monthly mortgage payment is required,” Linger said. “You can make payments if you like, but no monthly mortgage payment is required.”
If you choose not to make any mortgage payments, the interest on your loan accumulates until you (or a surviving spouse, moves out of the home, or dies. At that point, you heirs will be responsible for repaying the reverse mortgage, or they will have to deed the home to the lender to settle the debt.
The same rules that apply to conventional HECMs apply to HECMs for Purchase – you need to pay taxes, insurance and homeowner’s association fees, and you’re required to keep the house in good condition.
The major drawback to a HECM for Purchase is meeting the loan-to-value ratio required in a reverse mortgage. In 2018, with low interest rates available, the homeowner could borrow somewhere between 40%-55% of the value of their home.
For example, let’s say you and your spouse are 62 years old and sell your $100,000 home in one state and buy a house closer to your children that costs the same amount. The formula for determining your down payment says you need a 50% loan-to-value ratio, or $50,000, to get a HECM for Purchase reverse mortgage on the home you want to buy.
That means you will need a loan of $50,000 to complete the purchase. The HECM for Purchase reverse mortgage provides that at 5% interest. You are not required to make any mortgage payments.
Instead, the amount due on the HECM for Purchase reverse mortgage grows by 5% every year so that after 10 years, the $50,000 loan is now up to $75,000. If you and your spouse die or relocate to an assisted-living facility at that point, your estate is responsible for paying the $75,000.
If the house has appreciated over the 10 years and sells for $125,000, then $75,000 goes to the bank to cover the cost of the reverse mortgage and $50,000 goes back into your estate. If the house depreciates over the 10 years and only sells for $75,000, that money is used to pay off the loan and nothing goes back to the estate.
Proprietary Reverse Mortgages
Proprietary reverse mortgages are private loans that lack the government insurance of HECMs. Their primary edge for homeowners is they generally offer bigger loan advances to those with more expensive homes.
HECMs in 2018 are limited to properties worth $679,650, but proprietary reverse mortgages have no such limit. HUD does not regulate proprietary mortgages so there is no government requirement that you receive counseling before applying for a loan, but the lending agent may require it.
Also, you can only receive a lump-sum payment from a proprietary reverse mortgage, as opposed to several payment options available with HECMs.
Proprietary reverse mortgages are mostly used for homes that exceed the appraised-value cap imposed on HECMs.
Single-Purpose Reverse Mortgage
Single-purpose reverse mortgages are the least expensive reverse mortgages, since their proceeds can only be used for a single, agreed upon use. They are sometimes offered by state or local government agencies or nonprofit organizations.
Money from a single reverse loans can be used to replace a roof, improve plumbing, pay taxes or cover some other expensive outlay. Typically, they are designed for homeowners with low- to moderate-incomes and they aren’t available everywhere. They are particularly useful to homeowners who can’t qualify for other types of reverse mortgages.