These days, because the costs of living seem to be higher than ever before, a record number of senior homeowners are considering reverse mortgage loans that convert their home equity into available income. Although reverse mortgages may provide an affordable way to obtain needed funds, they can sometimes turn out to be much more expensive than standard home loans.

The Fundamentals

In order to approve a reverse mortgage, lenders require that all current owners sign on as borrowers. This means that spouses, joint tenants, and tenants-in-common must be named and approved as borrowers on the loan agreement. Each borrower must be 62 or older, and must be living in the home as a principal residence.

In a conventional forward mortgage the borrower makes payments to the lender. With each payment, the borrower’s debt decreases and equity increases.  In a reverse mortgage the opposite occurs. Since the lender makes payments to the borrower, the borrower’s debt increases and equity decreases. Reverse mortgage lenders determine exactly how much may be borrowed based on the borrower’s age and the home’s present value.

Most reverse mortgage loans do not have to be repaid until the borrower dies. However, if the borrower moves to a new principal residence, leaves the home for more than 12 consecutive months, fails to pay property taxes or hazard insurance, or doesn’t make needed home repairs, the entire loan may become immediately due and payable.  At such point, if the borrower is unable to fully repay, the lender may foreclose.

Types of Reverse Mortgages

Federally insured reverse mortgages known as Home Equity Conversion Mortgage (HECMs) are insured by the Federal Department of Housing and Urban Development (HUD), offered by the Federal Housing Administration (FHA) and provide consumers with increased protections. As long as the borrower complies, all HECM contract terms will remain in effect. As a result, the borrower will be completely protected if the property value declines or the lender goes bankrupt. For the year 2013, HECM loans cannot be more than $625,500.

Single purpose reverse mortgages, are products offered by some state and local government agencies and nonprofit organizations.

Proprietary reverse mortgages are private loans that are backed by the companies that develop them.

Loan Proceeds and Service Fees

HECM borrowers may choose whether to receive the loan as a single lump sum of cash, monthly cash advances, or a set credit line.  With a set credit line, the borrower who withdraws less than the approved loan amount may treat the remaining portion as an interest-bearing savings account being held by the HECM lender.

Just like other home loans, reverse mortgage expenses include origination fees, servicing and set aside fees, and closing costs.  The main difference is that with a reverse mortgage, such fees do not need to be paid up-front, but are added to the loan’s balance.  Another difference is that HECM lenders require borrowers to purchase a Mortgage Insurance Premium (MIP) to make sure that – regardless of how much the borrower actually receives – the amount owed cannot be greater than the home’s ending market value.  Effective 9/30/13, a new MIP cost structure was adopted: 0.50% of the appraised value of the home is assessed when up to 60% of loan amount is taken in first year.  If more than 60% is taken, then 2.50% is charged.  The annual MIP is set at 1.25 percent of the outstanding balance.

Not only will compounded interest immediately start accruing on the amount borrowed, but also on the required service fees.  Effective 4/1/2013, the HECM standard product option is only available with an adjustable interest rate.  Interest is charged only on the amount received.

The Pros and Cons of a Reverse Mortgage Loan

Here’s an example:

Anna, a single woman, age 75, owns her home that has a current appraised value of $500,000. She obtains an HECM-approved lifetime reverse mortgage loan that will provide her with cash advances of $2,100 each month.
Included in the amount borrowed will be an origination fee of $5,250, a closing cost of $1,500, and a MIP of $2,500. The total processing charges are therefore $9,250, plus interest. Although present rates are a bit lower, in this example the loan’s annual interest rate will be 2 percent.  Anna begins receiving monthly advances of $2,100.

Scenario #1:  Anna lives to the age of 95, receiving monthly payments of $2,100 that after 20 years will have totaled $504,000. That amount, combined with the processing fees of $9,250, will total a repayment obligation of $513,250, plus annual interest of 2 percent that started accruing when the agreement commenced.
Should the assessed value of Anna’s home remain at $500,000, her estate will only need to repay the lender $500,000. The income security provided by Anna’s reverse mortgage loan would be well worth its cost.

Scenario #2:  Anna receives monthly advances for two years, at which time she suffers an unexpected illness and needs to move out of her home to receive skilled nursing home care. Since she is unable to reside in her home for more than 12 months, her reverse mortgage loan will terminate. It has already provided her with income totaling $50,400, but her existing loan obligation includes repayment of the $9,250 processing fees, plus accrued interest.

In short, her repayment obligation now exceeds $59,650. Since the loan lasted for a much shorter time than was anticipated, Anna’s loan processing fees of $9,250 will be almost 6 percent of the borrowed sums – yet the interest rate agreed to was just 2 percent!   If Anna cannot repay the existing loan balance, she will have to sell the home or sit back as the lender proceeds with foreclosure.

Final Note

For seniors who rely on the family home as their primary financial asset, a reverse mortgage may be highly beneficial. It will provide them with the ability to receive a monthly income that will continue, regardless of a possible decrease in the home’s fair market value. However, in the worst, yet not uncommon scenario, should the borrower’s loan terminate in too short a time, the lender will still be able to collect all sums due.  In such a scenario, the costs of a reverse mortgage may well be too high.

According to the Consumers Union study, “Examining Faulty Foundations in Today’s Reverse Mortgages,” reverse mortgages should be considered suitable only when a senior has no other viable options. For a copy of the study (www.consumersunion.org/pdf/reverse-mortgage-report-2010.pdf)

For other information:

  • HUD provides a list of its approved housing counseling agencies online at hud.gov, and in the search box type in “housing counseling agency” or call 800-569-4287.
  • Click here for an estimate of HECM cash benefits based on your age, home value and current interest rates.
  • “Your Guide to Reverse Mortgage” by NRMLA, at www.reversemortgage.org