What is A Reverse Mortgage?
A reverse mortgage is a loan against a home that does not have to be repaid as long as the homeowner lives at the residence. Reverse mortgages are available to homeowners age 62 or older and who have equity in their home. In some circumstances, reverse mortgages may be a prudent way for older homeowners to supplement their incomes or pay for large one-time expenses. But homeowners should consider carefully all of the terms of these complex financial products, especially the required costs of mortgage insurance, before making the decision to get a reverse mortgage.
Almost all reverse mortgages available in the United States are part of the Home Equity Conversion Mortgage (“HECM”) program of the U.S. Department of Housing and Urban Development’s Federal Housing Administration. This program requires that borrowers pay an upfront insurance premium that makes entering into a reverse mortgage costly. A new program, called HECM Saver, reduces the upfront cost of reverse mortgages by eliminating this initial insurance payment.
Who Can Get a Reverse Mortgage?
Here are the basic requirements of the Federal Housing Administration’s reverse mortgage program:
- Homeowners must be 62 years of age or older. When two people are on the title the younger one must be at least 62.
- The property used to obtain the reverse mortgage must be the primary residence of the borrower. It can be a single family residence in a 1-4 unit dwelling, a condominium, or a manufactured home.
- The maximum amount homeowners can borrow is based on their age, the appraised value of their property and the median home value in the region.
- When there are two borrowers, the younger homeowner’s age is used to determine the maximum loan amount.
- The borrower must pay mortgage insurance premiums in addition to a loan origination fee and other typical mortgage expenses. These expenses can be wrapped into the loan.
- The borrower does not have to meet minimum credit requirements beyond not being delinquent on any federal debt.
- Borrowers must keep property insured and in good repair and pay property taxes.
- Borrowers must receive counseling from a government-approved counselor.
How Does a Reverse Mortgage Work?
Unlike a traditional mortgage where the amount borrowed declines over time as the homeowner makes monthly payments, a reverse mortgage is characterized by rising debt over time. The maximum amount that a homeowner can borrow against their home’s equity is based on the homeowner’s expected lifespan. In general, an older homeowner can borrow more than a younger homeowner. The amount borrowed and the accumulated interest must be repaid when the homeowner no longer occupies home (for example, after the homeowner’s death). If not repaid, the lender will take possession of the home.
What are Mortgage Insurance Premiums?
Homeowners must pay a mortgage insurance premium to obtain a reverse mortgage. This insurance compensates the lender in case the homeowner lives in their home for a longer period than predicted by their expected lifespan or if the value of the property turns out to be less than expected.
Standard reverse mortgages, known as HECM Standard, require an initial 2% insurance premium on the maximum loan amount a borrower can receive. Homeowners also must pay a 1.25% premium every year on the size of the outstanding loan. These high insurance premiums are one of the main reasons why many financial advisors recommend that reverse mortgages only be used as a last resort.
The new Federal Housing Administration reverse mortgage program called HECM Saver has lower initial insurance premiums of only 0.01% of the maximum loan amount. Homeowners must still pay the annual 1.25% insurance premium in this program. The draw-back of this program is that the reduction in the initial insurance premium results in a reduction of the maximum amount that can be borrowed.
What Payment Options Are Available?
An appealing aspect of reverse mortgages is that homeowners can receive their borrowed amounts in many ways. The money can come as a lump sum at closing, a credit line, a series of fixed monthly payments for a defined period of time, or as fixed monthly payments for as long as the homeowner lives in their home. The homeowner can also receive a reverse mortgage loan with a combination of these forms, and may be able to change the mix of payments during the course of the loan. Homeowners should talk to a financial counselor about which of these options is best for them.
Drawbacks of Reverse Mortgages
Reverse mortgages are an expensive way for homeowners to access the equity they have built up in their primary residence. If the homeowner has other sources of income, a traditional mortgage or a home equity line of credit may make more sense. Reverse mortgages can be especially expensive for homeowners who only occupy their home for a few years after receiving a reverse mortgage.
Homeowners should be wary of any lender who encourages a reverse mortgage option that is not in the homeowner’s best interest. For example, homeowners should not feel pressured to take a lump-sum amount when they have no immediate need for the cash. Reverse mortgage lenders are not permitted to sell homeowners other financial products to reinvest the loan proceeds.
Homeowners need to have a clear understanding of how reverse mortgages work. After the homeowner dies or moves out of the property, the loan must be repaid or the lender will take possession of the home. This means that other family members (such as a spouse who was not an owner of the property) must repay the loan or move out of the property.
For More Information:
The U.S. Department of Housing and Urban Development provides information on their Home Equity Conversion Mortgages for Seniors program.
The Federal Trade Commission also has useful information on reverse mortgages.
The AARP has a primer on the issue as well.