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.
Borrower Requirements *(HUD loans unless otherwise specified)
- Be 62 years of age or older
- Own the property outright or paid-down a considerable amount
- Occupy the property as your principal residence
- Not be delinquent on any federal debt
- Have financial resources to continue to make timely payment of ongoing property charges such as property taxes, insurance and Homeowner Association fees, etc.
- Participate in a consumer information session given by a HUD approved loan counselor
The following eligible property types must meet all FHA property standards and flood requirements:
- Single family home or 2-4 unit home with one unit occupied by the borrower,
- HUD-approved condominium project,
- Manufactured home that meets FHA requirements.
- Income, assets, monthly living expenses, and credit history will be verified.
- Timely payment of real estate taxes, hazard and flood insurance premiums will be verified.
In order to approve a reverse mortgage, HUD 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.
FHA has implemented several reforms to improve its reverse mortgage Home Equity Conversion Mortgage (HECM) program since the Housing and Economic Recovery Act of 2008 and the Reverse Mortgage Stabilization Act of 2013. One of those changes, implemented in June 2015, helps surviving non-borrowing spouses avoid foreclosure and stay in their home after the death of the borrowing spouse. Other reforms include limited initial withdrawals and fund set-asides to ensure financial stability of the program; required financial assessments for HECM borrowers to determine if their reverse mortgage is sustainable in the long term; and strengthening prohibitions against deceptive advertising of HECM programs.
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 2021, HECM loans cannot be more than $822,375.
Single purpose reverse mortgages are products offered by some state and local government agencies and nonprofit organizations.
Proprietary reverse mortgages are private loans by contract that are backed by the companies that develop them. For property valued over $850,000, proprietary jumbo loans are now available with some financial advantages such as larger loan amounts, no MIP cost, and possibly lower interest rates, however, there are disadvantages such as the non-borrowing spouse is not protected under HECM guidelines ensuring that they will not be forced out of the property if the borrower must leave for long term-care or dies. Also jumbo loans up to $10 million required borrower accept a line of credit; single payment is not available in this type of loan.
Loan Proceeds and Service Fees
In reverse mortgages, the borrower gets the maximum claim amount through a line of credit, lump sum, periodic/term payments, or a combination of two options. 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.
This maximum claim amount is a combination of many factors, beginning with the age of the youngest borrower or that of an eligible non-borrowing spouse. If one or more borrowers are on the mortgage and no eligible non-borrowing spouse exists, the youngest borrower’s age will be taken into account to calculate the maximum claim amount. Moreover, the current interest rate of the HECM affects how much the borrower can get. This interest rate is calculated on a monthly basis just like any loan, but it is not paid until such time as the reverse mortgage becomes due and payable.
Lastly, the maximum amount that can be borrowed by the senior homeowner is whichever is lowest of three factors:
- the appraised value of the home, or
- the sales price of the home, or
- the prevailing HECM loan limit ($822,375 for 2021).
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. This insurance protects the lender, nor the borrower and payment is at the borrower’s expense.
These fees vary from lender to lender, though they are capped by the FHA. For homes that are valued at $200,000 or less, the origination fee is capped at 2% or $2,500, whichever is greater. For homes worth more than $200,000, the lender is allowed to charge 2% on the first $200,000 and 1% on the value of the home above $200,000, for a maximum of $6,000.
The initial MIP is set at 2.00% of the value of the home or HECM limit for all borrowers. The annual MIP for 2021 is set at .5% of the outstanding balance. If there’s a servicing fee, it’s typically between $25 and $35. If the loan has an interest rate that adjusts every year, the fee may be no greater than $30. If the rate adjusts every month, the cap is set at $35. The servicing fee for the first month is taken out at closing, and you continue to pay it throughout the life of the loan. These days servicing fees are much less common.
There are other closing fees, sometimes called third party fees, that you may need to pay as well. These include appraisal and survey fees, title and title insurance fees, inspection costs, credit checks and miscellaneous fees. As a general rule of thumb, expect these to cost $1,000-2,000.
Not only will compounded interest immediately start accruing on the amount borrowed, but also on the required service fees. Interest is charged only on the amount received. A reverse mortgage loan accrues interest similar to a traditional mortgage except the homeowner is not making payments (interest or principal) each month to reduce the loan balance. As a result, the loan balance grows with a reverse mortgage until the loan becomes due, usually when the homeowner permanently moves out of the property or passes away.
Interest rates are offered as fixed or adjustable HECMs. Until 2007, all reverse mortgages were adjustable; according to a report released by the Consumer Finance Protection Bureau in 2012, 70% of loans are fixed rate. In 2013, the FHA made major changes to the HECM program and now ~90% of loans are adjustable yet again. Adjustable loans may adjust on a monthly, semi-annual, or annual basis, but in practice almost all lenders offer monthly adjusting products.
An adjustable HECM is composed of an index and a margin, which is set by the lender. The margin never changes after the loan is originated, while the index fluctuates according to the market. Adjustable HECMs use either the Constant Maturity Treasury Index (1 Year or 1 Month) or the London Interbank Offered Rate (LIBOR, 1 month).
For fixed interest rate mortgages, you can only receive the Single Disbursement Lump Sum payment.
Over the last few years, the interest rates on reverse mortgage loans have fluctuated between 3% and 7%. The true interest rate is two percentage points above the quoted rate because the total rate includes the FHA’s ongoing Mortgage Insurance Premium (MIP) charges. For example, if the quoted rate is 4.51%, with the MIP charges of 2%; the total rate would be 6.51%.
The Pros and Cons of a Reverse Mortgage Loan
Reverse mortgages are not products that may be suitable for all people. You must consider if you wish to leave your family an inheritance, if you will continue to live in your home for the duration of your life, and if your resources will continue to support your ability to maintain your property. These issues may not be relevant for some seniors who may rely on their family home as their primary financial asset. For those seniors, a reverse mortgage loan may be beneficial and may be a good choice. 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.
Most people who take out reverse mortgages do not intend to ever repay them in full. In fact, if you think you may plan to repay your loan in full, then you may be better off avoiding reverse mortgages altogether.
However, generally speaking, reverse mortgages must be repaid when the borrower dies, moves, or sells their home. At that time, the borrowers (or their heirs) can either repay the loan and keep the property or sell the home and use the proceeds to repay the loan, with the sellers keeping any proceeds that remain after the loan is repaid.
The borrower may need to repay a mortgage either with cash or by selling the home if:
- They have to move into an assisted living facility or have to move in with a family member to help take care of them
- They have family who lives with them who want to keep the property, and they have the money to pay back the loan (for example, by borrowing against a life insurance policy or having their heirs use the death benefit to pay off the loan)
- They are unable to keep up with maintaining the property or pay the taxes or Homeowner Association dues in a timely manner.
However, in the worst scenario, should the borrower’s loan terminate prematurely due to default in the terms of the loan, the lender could call the entire loan amount, including interest, fees and court costs, and will still be able to collect all sums due even in foreclosure and leave the senior homeless. In such a scenario, the costs of a reverse mortgage may well be too high.
If a borrower should change their mind about the reverse mortgage, there is a provision or cancellation clause, known as the Reverse Mortgage Right of Rescission. If for any reason, a borrower is unhappy with their decision and/or wish to cancel the reverse mortgage, they have 3 business days to do so. That’s 3 days after they already signed the documents and have technically already obtained the reverse mortgage. To cancel, they must notify the lender in writing. They should send the letter by certified mail, and ask for a return receipt. That will let the borrower document what the lender got, and when. Keep copies of the correspondence and any enclosures. After the cancellation, the lender has 20 days to return any money that has been paid for the financing.
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: (https://advocacy.consumerreports.org/wp-content/uploads/2013/02/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.
- Go to https://www.newretirement.com/services/reverse_mortgage_calculator.aspx 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
Updated on January, 2021