Reverse Mortgages Explained
Watching a television commercial where a familiar personality talks about reverse mortgages may generate both interest and questions about that financial tool. Those television spots highlight the benefits of reverse mortgages as an attractive option for generating cash for senior homeowners and allowing those homeowners to stay in their homes. While receiving cash to supplement income and staying in one’s home are goals most anyone would love to attain, research and due diligence should be performed to determine if a reverse mortgage is an option for those who qualify.
The Federal Housing Authority (FHA) Home Equity Conversion Mortgage, also referred to as an HECM or reverse mortgage, was signed into law on February 5, 1988 by President Ronald Reagan as part of the Housing and Community Development Act of 1987. The first HECM or reverse mortgage was given to Marjorie Mason of Fairway, Kansas, in 1989 by the James B. Nutter Company. A reverse mortgage is a special kind of loan that lets homeowners access the equity in their homes, increasing their income without increasing monthly payments, and permitting the homeowner to remain in their home. It is also a method for keeping a primary residence in the family if all involved understand the requirements.
Homeowners must be 62 years of age or older, and a married couple can qualify if at least one of them is that age. The property must be the homeowners’ primary residence and can be a single family home, condominium, certain qualifying manufactured homes, or a multiplex with four or fewer units, provided the owner uses one of the units as a primary residence. If the property has a small mortgage balance, some of proceeds from the reverse mortgage must be used to pay off the existing mortgage. Potential borrowers are required to receive consumer information for free or at a very low cost from an HECM counselor who is independent from the lender.
While not having to undergo the rigors of qualifying for a traditional mortgage, potential borrowers must still undergo a financial assessment to verify their assets and liabilities to determine if the borrowers’ current financial status can be sustained for the foreseeable future, and to demonstrate their financial ability to continue to pay future maintenance, property taxes and any other ongoing expenses. The property must be in good condition, and if major repairs are needed, those must be completed before the loan proceeds are received.
The Dollar Amounts
The amount of money received is determined by a number of factors, including the borrower’s age, the value and location of the home, the amount of equity in the home, the type of interest rate (fixed or adjustable), current interest rates, and how the funds are to be distributed. The funds may be distributed in one of the following ways:
- A lump sum at closing
- Monthly payments for a set number of years (“term”) or for life (“tenure”)
- A line of credit
- Some combination of the above three options.
It is important to note that the adjustable rate reverse mortgage offers all of the above payment options, while the fixed rate reverse mortgage only offers the lump sum payment option. There are no limitations on how the funds can be spent. There are, however, limits to the amount of the proceeds that can be accessed during the first 12 months of the loan. These limits were designed to protect borrowers from taking the full dollar amount paid at closing and spending the money quickly, rather than receiving additional cash and financial security over a period of time.
An advantage of a reverse mortgage over a home equity line of credit is that there are no monthly payments due. In addition, the reverse mortgage does not have to be repaid within a certain period of time, or ever. The mortgage only has to be repaid when the last homeowner dies, sells the house, or moves out of the property for any reason and does not live in the house for longer than 12 months. The reverse mortgage could also be due and payable if the borrower fails to pay property taxes, homeowners’ insurance, lets the condition of the property deteriorate, or transfers title to the property to a non-borrower.
When the mortgage is due for whatever reason, the borrower or the heirs could pay off or refinance the mortgage and keep the property. If the borrower or the heirs are not interested in keeping the property, they can sell the property and pay off the mortgage. If the borrower or the heirs do not want to repay the mortgage, the lender will sell the property. If the sales price is greater than the mortgage, the borrower or the heirs will receive the difference. But if the sales prices is less than the mortgage, the proceeds are applied first to the mortgage balance and the lender can apply to HUD to make up the difference. The borrower can never owe more than the value of the property and cannot pass on any debt from the reverse mortgage to the heirs. Because a reverse mortgage is a non-recourse loan, it is the only asset that can be claimed by the lender to repay the mortgage.
The fees for a reverse mortgage are generally higher than for a conventional mortgage but are similar to those costs. Some of the costs associated with a reverse mortgage include:
Counseling fee: This fee averages about $125, but some counselors waive the fee.
Origination fee: The fee charged by the lender to process the reverse mortgage. This fee varies by lender, so do the research and compare fees among several lenders.
Interest rate: The rates charged are determined by the type of loan (fixed or adjustable rate), current interest rates and the lender. These fees also vary by lender, so do the research and compare fees among several lenders.
Third party fees: Fees charged for the appraisal, title insurance, escrow, title recording, credit reports, and other similar fees.
Initial mortgage insurance premium: A one-time cost paid at closing to the FHA for insurance. This insurance is used to repay lenders if there is a deficit between the reverse mortgage balance and the sales price of the property. It also protects the borrower or the heirs so that no other assets can be used to repay the loan or deficit between the sales proceeds and the reverse mortgage balance. This premium and the origination fee are generally the largest closing costs.
The PROS of a Reverse Mortgage:
- The reverse mortgage is simply a lien against the property and the borrower does not give up title to their property.
- No monthly payments are required.
- Funds received can help with unexpected expenses or improve cash flows.
and the CONS:
- Fees and other closing costs can be high.
- The borrower must maintain the property and pay all expenses relating to the property.
- A reverse mortgage can impact a family’s desire to keep the property in the family.
Only you and your financial advisor can determine if a reverse mortgage is a financial option to be considered for your specific circumstances. Let the professionals at REDW Stanley help with that decision.
© Eldon Dedini
Copyright 2017 REDW Stanley Financial Advisors, LLC. All Rights Reserved. This publication is intended for general informational purposes only and should not be construed as investment, financial, tax, or legal advice.