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 asset. 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.
Types of Reverse Mortgages
Home Equity Conversion Mortgage (HECM) was established by HUD in 1987 under the Housing and Community Development Act and is the original form of reverse mortgage created by the act. The Home Equity Conversion Mortgage is a loan designed for seniors (62 years of age or older) that allows them to access a portion of their home’s value using that home as collateral and is insured by HUD, offered by the Federal Housing Administration (FHA) and provides consumers increased protections. In 2008, the reverse for purchase was rolled out. Significant changes regarding financial assessment (2014) and non-borrowing spousal protection (2015) have since been adopted to strengthen and protect the viability of the HECM program.
Proprietary reverse mortgages are private contractual loans, usually, although not always, for property valued primarily over $850,000 and that are backed by the companies that develop them. Proprietary jumbo loans are 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 as under HECM guidelines which ensure that they will not be forced out of the property if the borrower must leave for long term-care or dies. and these types of loans are not Federally insured. Although their initial market has been higher priced homes, these new products solve other problems that HECMs currently do not, such as:
- Providing financing for non-FHA approved condos;
- No 60% limit for accessing funds in the first year;
- Pay-off of unsecured debt at closing for qualifying;
- Some proprietary lenders make loans to borrowers as young as 55;
- Fixed and adjustable-rate products with hybrid lines of credit.
Single purpose reverse mortgages are products offered by some state and local government agencies and some nonprofit organizations, but they’re not available everywhere and often depend on available funding. According to the Federal Trade Commission (FTC), these loans may be used for only one purpose, which the lender specifies. These limited loans are primarily either for property repairs that are necessary to alleviate health and safety concerns, or, to pay property taxes. California’s property tax assistance loan program is currently suspended due to lack of funding. Only senior citizens with low or very low incomes have access to these loans, when available. These non-HECM loans are not federally insured.
*All loan types require potential borrowers to participate in a consumer information session given by a HUD- approved HECM counselor prior to loan application.
REVERSE MORTGAGE VS CONVENTIONAL MORTGAGE
In a conventional forward mortgage, the borrower must meet the lender’s financial qualifications for the loan and the borrower makes forward payments to the lender to repay the loan amount over the pre-determined term of the loan. With each payment, the borrower’s debt decreases, and equity generally increases.
With a reverse mortgage, a financial assessment of the borrower’s willingness and ability to pay property taxes and homeowner’s insurance is required, but payments are optional. The majority of reverse mortgage borrowers choose not to make them. This results in a condition known as negative amortization, meaning that the loan balance increases over time instead of decreasing. The term of the loan ends with the long-term absence or death of the borrower or the repayment of the amount due and owing on the loan.
All reverse mortgages, whether FHA insured or not, must be non-recourse meaning that the borrower or their heirs can never owe more than the property is worth.
Loan Proceeds and Interest Rates
In general, the older you are, the more equity you have in your home, and the less you owe on it, the more money you can get. The amount a borrower is eligible for (known as the principal limit) is based on these factors:
- Age of youngest borrower (or non-borrowing spouse),
- Value of the property, capped in 2022 at $970,800 for FHA loans (PLEASE NOTE: this number refers to the maximum VALUE considered under the FHA program, not the principal limit), and
- The current interest rate for the desired
According to the Federal Trade Commission (FTC), the HECM loan lets you choose among several payment options for the loan proceeds:
- a single disbursement option – this is only available with a fixed rate loan, and typically offers less money than other HECM options.
- a “term” option – fixed monthly cash advances for a specific time.
- a “tenure” option – fixed monthly cash advances for as long as you live in your home.
- a line of credit – this lets you draw down the loan proceeds at any time, in amounts you choose, until you have used up the line of credit. This option limits the amount of interest imposed on your loan, because you owe interest on the credit that you are using.
- a combination of monthly payments and a line of credit.
(Note: Proceeds from a reverse mortgage are not income and therefore are not taxable).
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.
Interest rates for fixed rate reverse mortgages vary and tend to be slightly higher than their conventional cousins. As stated above, with the fixed rate loan, there is only one payout option – a lump sum disbursement at closing. This may be a good choice if your existing loan balance is close to what you would qualify for. However, if your mandatory obligations (all required payoffs plus closing costs) are less than 60% of the principal limit, you may end up leaving proceeds on the table. You could receive a lump sum disbursement, convert the proceeds into a monthly payment for life (tenure payment), request a certain amount for a specified period of time (term payment), or leave some or all of the proceeds on a line of credit. You can also have combinations of the above.
The adjustable-rate product offers more flexibility. An adjustable HECM is composed of an index and a margin, which is set by the lender. The adjustable-rate is based on either the Constant Maturity Treasury Index or SOFR (Secured Overnight Financing Rate) which adjust periodically per the terms of the note, plus a fixed margin as determined by the lender, and comes with either a 5% or 10% life cap on the loan. The margin never changes after the loan is originated, while the index fluctuates according to the market.
The reverse mortgage line of credit (LOC) is unique in the financial world in that any funds left on it grow at the same rate as the loan. This is NOT interest but increased access to borrowing power (similar to getting an increased credit limit on your VISA). Any payments the borrower chooses to make to reduce their loan balance, also increase the funds available on their LOC. Once the LOC is established, it grows independent of the value of the home and cannot be reduced, frozen, or eliminated*.
*as long as at least one borrower lives in the property and continues to meet all requirements.
Fees and Costs
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, according to HUD, is that HECM loans require a cost for FHA mortgage insurance (MIP). The mortgage insurance guarantees that you will receive expected loan advances. The funds accrued by MIP charges also essentially make HECM lenders whole if the loan balance ever exceeds the value of the home. These mortgage insurance premiums are included as part of your loan. You will be charged an initial mortgage insurance premium (MIP) at closing. The initial MIP will be 2% of the home’s appraised value or FHA lending limit ($970,800), whichever number is less. Over the life of the loan, you will be charged an annual MIP. The annual MIP for 2022 is set at .5% of the outstanding balance.
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.
Lenders or their agents provide servicing throughout the life of the HECM. Servicing includes sending you account statements, disbursing loan proceeds and making certain that you keep up with loan requirements such as paying real estate taxes and hazard insurance premium. Lenders may charge a monthly servicing fee of no more than $30 if the loan has an annually adjusting interest rate or has a fixed interest rate. The lender may charge a monthly servicing fee of no more than $35 if the interest rate adjusts monthly. At loan closing, the lender sets aside the servicing fee and deducts the fee from your available funds. Each month the monthly servicing fee is added to your loan balance. Lenders may also choose to include the servicing fee in the mortgage interest rate. These days servicing fees are much less common.
Closing costs from third parties can include an appraisal, title search and insurance, surveys, inspections, recording fees, mortgage taxes, credit checks and other fees.
HECM Non-Borrowing Spouses (NBS)
A non-borrowing spouse is the spouse of a HECM borrower, who was not named as a borrower in the original loan application and legal documents. This often occurs when the spouse was not 62 years of age when the loan was originated; did not have title to the property or in order to secure the maximum amount, or principal limit, for the HECM.
Upon the death of the last surviving borrower, the balance of the HECM loan becomes due and payable. At this point, the non-borrowing spouse may not withdraw any unused loan funds; however, FHA mortgage insurance premiums, and service fees will continue to accrue on the unpaid principal balance.
The Department of Housing and Urban Development (HUD) permits eligible Non-Borrowing Spouses (NBS) the opportunity to continue to live in the mortgaged property after the death of the last remaining HECM borrower provided they meet all the established requirements and the HECM is not in default for any other reason (such as failure to pay required property taxes or hazard insurance payments).
HECM’s originated on or after August 4, 2014, provide that an eligible n0n-borrowing spouse may continue to live in the mortgaged property after the death of the last surviving HECM borrower, if the following conditions are met, and continue to be met:
- The Non-Borrowing Spouse is named in the loan documents as a Non-Borrowing Spouse; and
- The HECM loan cannot be in default (eligible to be called due and payable) for any reason other than the last borrower’s death (e.g., failure to pay property taxes or make hazard insurance payments); and
- The borrower and his or her spouse were either:
- Legally married at the time the HECM closed and remained married until the HECM borrower’s death.
- Engaged in a committed relationship akin to marriage but were legally prohibited from marrying before the closing of the HECM because of the gender of the borrower and Non-Borrowing Spouse, if the spouses legally married before the death of the borrower and remained married until the death of the borrowing spouse; and
- The Non-Borrowing Spouse lived in the property at loan closing and continues to live in the property as his or her principal residence; and
- The Non-Borrowing Spouse has (or obtains within 90 days after the death of the last surviving borrower) “good, marketable title” to the property or some other legal right to remain in the property (e.g., executed lease, court order, etc.) for the rest of the Non-Borrowing Spouse’s life.
A reverse mortgage becomes due when a maturity event occurs:
- The property is no longer the principal residence of at least one borrower;
- The last borrower fails to occupy the property for twelve consecutive months `because of mental or physical illness;
- A borrower does not fulfill their obligations under the terms of the loan. Common examples would include failure to maintain the home in good condition or failure to pay property taxes, property insurance, or other property charges.
These maturity events do not necessarily cause the loan to become due and payable. FHA has allowed the due and payable status of a HECM to be deferred if a non-borrowing spouse (NBS) is still occupying the home.
A WORD OF CAUTION – It’s important to note that under current law, the only maturity event that qualifies for the NBS deferral is the death of the last borrower. If the borrowing spouse moves out of the home into assisted living, the NBS would not qualify for a deferral, and the loan would become due and payable.
THE PROS AND CONS OF REVERSE MORTGAGE
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
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 for more than 12 consecutive months,
- 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, insurance, or Homeowner Association dues in a timely manner.
However, in dire circumstance, 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 due and payable. The National Reverse Mortgage Lenders Association (NRMLA) states, “A HECM loan is like any loan in that if you can no longer meet the conditions of the loan, it is in Default. The default condition must be cured, or the loan debt must be resolved in some acceptable manner, otherwise the property may be foreclosed upon to resolve the debt. Please know that not all HECM loans are resolved by foreclosure”. NRMLA offers a detailed guide on the various ways to avoid possible foreclosure. The essential point is that borrowers and their heirs must keep in close contact with the lender as to their circumstance to work out a solution to avoid potential foreclosure. Proprietary contractual reverse mortgage loans may have substantially different provisions regarding default and for any flexibility in avoiding foreclosure than HECM loans. These lenders are not bound by the same guidelines.
Right of Rescission
As with all mortgage loans, if a borrower should change their mind about a reverse mortgage loan, with certain exceptions, they are subject to a provision or cancellation clause known as the Reverse Mortgage Right of Rescission, established by the Truth in Lending Act (TILA) under U.S. federal law. If for any reason, a borrower is unhappy with their decision and/or wish to cancel the reverse mortgage, they have three (3) business days, including Saturdays, to do so. That’s 3 days after the documents are signed. This provision does not apply to a reverse mortgage loan that is to purchase property or a loan from the original mortgage lender. 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 it, and when. Retain 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.
For other information:
- HUD provides a list of its approved housing counseling agencies online at gov, and in the search box type in “housing counseling agency”or call 800-569-4287.
https://www.newretirement.com/services/reversemortgagecalculator.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; reversemortgage.org
- NRMLA – National Reverse Mortgage Lenders Association – What is a Reverse Mortgage? https://www.reversemortgage.org/about/
- NRMLA – News coverage https://www.nrmlaonline.org/news-coverage
- NRMLA – What You Need to Know About Your HECM After Closing https://www.nrmlaonline.org/2019/01/01/need-know-hecm-closing
- Department of Housing & Urban Development (HUD) https://www.hud.gov/program_offices/housing/sfh/hecm/hecmhome
- NCOA – National Council on Aging – Use Your Home To Stay At Home https://www.ncoa.org/article/use-your-home-to-stay-at-home
- NCOA – Get The Facts About Reverse Mortgages https://www.ncoa.org/article/get-the-facts-on-reverse-mortgages