Tue. Nov 24th, 2020

A reverse mortgage could allow you to access your home’s equity without selling or moving from your property. That could come in handy if you need help with retirement expenses, but you could deplete the equity in your home. It’s important to understand how reverse mortgages work before signing up, as some types of reverse mortgages have downsides.

  • How does a reverse mortgage work?
  • Is a reverse mortgage a good idea?
  • What will a reverse mortgage cost?

How Does a Reverse Mortgage Work?

A reverse mortgage borrows against your home’s equity. They’re available to seniors who hold equity in their homes. You’ll get cash out, but don’t have to sell your home. Reverse mortgages don’t have to be paid back as long as you continue to live in your home.

The mortgage loan is due when you move out, sell your home or pass away. If you or your heirs want to keep the property after that, you’ll have to pay the loan balance. Otherwise, the reverse mortgage lender will keep the home to settle the debt.

Who Is Eligible for a Reverse Mortgage?

Eligibility requirements can vary depending on the type of loan and the lender. Home equity conversion mortgages, or HECMs, have the following requirements:

  • You must be at least 62.
  • The property must be your primary residence.
  • Your home must be paid off or have a low mortgage balance.
  • You must be able to afford future housing costs.
  • You must have no delinquent federal debt.
  • You must satisfy property requirements, such as a single-family home or multi-family home you live in.
  • Meet with a Department of Housing and Urban Development-approved counselor.

If you are married, you and your spouse should both be listed as co-borrowers on the reverse mortgage loan so that if one spouse dies or has to move out for medical reasons, the other can continue living in the property and receiving money from the reverse mortgage.

What Are the Types of Reverse Mortgage Loans?

There are three major types of reverse mortgage loans: home equity conversion mortgage, proprietary reverse mortgage and single-purpose reverse mortgage.

Home Equity Conversion Mortgage

The home equity conversion mortgage is the most common type of reverse mortgage funding. These loans are insured by the U.S. government through the Federal Housing Administration, or FHA, a branch of HUD. If the amount you owe from the reverse mortgage grows to exceed the home value, the FHA will assume most or all of the loss.

You will pay a mortgage insurance premium to cover the potential for this type of loss, but it can be financed into the cost of your loan. The FHA limits the origination and servicing fees charged by reverse mortgage lenders for these loans. HECMs make sense for most properties valued at less than $1 million, says Peter H. Bell, CEO of the National Reverse Mortgage Lenders Association.

Proprietary Reverse Mortgage

Proprietary reverse mortgages are similar to HECMs, but they do not offer a government guarantee. They have fewer restrictions, and the lender could loosen eligibility requirements, such as eliminating the financial review with a HUD counselor. A proprietary reverse mortgage can be a jumbo reverse mortgage, which is a loan that exceeds HECM loan limits, so this can be a good option if you have a high-value property. But fees may be higher than an HECM.

The right reverse mortgage option depends on which programs you qualify for. “Proprietary loans are not available in every area,” Bell points out. “On the other hand, some properties do not qualify for an HECM reverse mortgage, like a condominium that doesn’t meet the FHA standards.”

An HECM for purchase can be used to buy a new home for your primary residence. You enter into a contract to buy your home, pay a down payment, and then finance the balance of the purchase with the reverse mortgage rather than paying cash or using a first-lien mortgage. The new home can’t be a vacation home or an investment property.

This strategy lets you complete everything in one transaction, and you will not owe monthly mortgage payments for your new home. Many seniors use an HECM for purchase to downsize or move closer to family members.

Single-Purpose Reverse Mortgage

With a single-purpose reverse mortgage, the lender restricts how you can use the money from a reverse mortgage. For example, you may not use the money to pay property taxes or to make home repairs. These reverse mortgages are typically the least expensive option, but they are limited in availability. Some state and local governments and nonprofits offer them, and they are typically for low- and moderate-income borrowers who may not be able to qualify for other types of reverse mortgages.

Is a Reverse Mortgage a Good Idea?

Access to home equity: With a reverse mortgage, you tap home equity without selling your home. These funds can offer extra money during retirement to pay off debt, maintain your lifestyle and handle surprise expenses.

No monthly mortgage payments: Like a reverse mortgage, a home equity loan borrows against your home’s equity. But with a home equity loan, you’ll make monthly payments. A reverse mortgage only needs to be repaid when you sell your house, move out or pass away, and it is typically paid for with the money from the sale of your home.

Maintain ownership of your home: A reverse mortgage lender doesn’t receive the title or the right to sell your house, so long as you keep up with the housing costs, including property taxes and homeowners insurance. The house remains yours until you move out or pass away. Even if you move out, you still have the option to pay off the loan to keep the property.

“With a reverse mortgage, people take their home equity and turn it into a flexible source of money,” Bell says. “This gives them more options during retirement. For example, when they need money, they can borrow through their line of credit rather than being forced to sell a stock that’s paying a nice dividend.”

Social Security and Medicare unaffected: When you receive money from a reverse mortgage, it counts as a loan, not as income. As a result, your Social Security and Medicare will not be affected.

What’s the Downside to Reverse Mortgages?

Despite their benefits, reverse mortgage loans erode your home equity and incur interest and fees like any other loan. Consider these drawbacks of reverse mortgages, below.

Fees: Reverse mortgage lenders charge a number of fees to close on and maintain a reverse mortgage. While you don’t have to pay the majority of fees until you leave your home, you could receive less money overall than if you had sold the home outright.

Interest: The reverse mortgage company will charge interest on what you borrow. It doesn’t have to be paid as long as you’re still living there, but it reduces your home equity – or what you’d receive when you sell your home.

Loan repayment: Your reverse mortgage loan must eventually be repaid. It’s due if you move out, sell the home or pass away. If you decide to downsize or move to a retirement community, you’d have to pay off your reverse mortgage – typically by selling the home.

Additional housing costs: While you don’t have to make loan payments on a reverse mortgage, you still need to cover other housing costs, such as property taxes, homeowners insurance, home repairs and association dues. If you fail to make these payments, the reverse mortgage lender could foreclose on your home.

However, Bell notes that this concern is not unique to reverse mortgages: “If you don’t pay your property taxes, you could eventually lose your home in any situation.”

Smaller inheritance: A reverse mortgage could reduce the inheritance for your heirs, as it reduces the equity in your home. If your heirs sell your home after your death, proceeds from the sale of the home will be used to pay off the loan, and then they will receive any remaining proceeds. If they want to keep your property, they will need to pay off the loan first.

“We often have clients that decide not to proceed with a reverse loan because they’re worried they won’t leave as much of an inheritance,” says Andrina Valdes, executive sales leader and COO at Cornerstone Home Lending. “We also counsel clients to think about discussing with their potential heirs before moving forward.”

How Much Can You Borrow on a Reverse Mortgage?

When you take out a reverse mortgage, the lender will let you borrow a percentage of your home equity. A reverse mortgage typically lets you borrow up to 60% of your home equity, but the actual amount you take out depends on a few factors, including:

  • Your age.
  • Appraised home value.
  • Current interest rates.
  • Type of reverse mortgage.
  • Your financial situation.

When you qualify for a reverse mortgage, you can choose to receive your money in the following ways:

  • Single disbursement: a lump-sum payout.
  • Tenure: monthly payments while you live in the home.
  • Term: monthly payments over a fixed amount of time.
  • Line of credit: an open line of credit that you can access when needed.
  • Combination: combines a line of credit with term or tenure payments.
  • Purchase: A lump-sum payout for buying a new property.

What Will a Reverse Mortgage Cost?

Reverse mortgage companies charge upfront fees to set up your loan as well as ongoing expenses. Fees will vary depending on the type of reverse mortgage you obtain, but you can expect these fees with an HECM:

You’ll pay these fees at or before closing.

  • Appraisal.
  • Closing costs.
  • Origination fees.
  • Initial mortgage insurance premium.
  • Points (optional for a lower interest rate).

Expect these fees for the life of the loan.

Loan interest: Reverse mortgages charge fixed or adjustable interest rates. A fixed rate stays the same over the entire reverse mortgage. An adjustable rate can change over time based on a market index. Your reverse mortgage will list how often the rate can change.

Valdes recommends that you research all the possibilities for loans. “Adjustable-rate mortgages often scare people, but the ARM features in an HECM can create more options and let the borrower use their equity more wisely,” she says. “A well-informed borrower makes better decisions.”

Mortgage insurance: You will continue paying mortgage insurance to the FHA for guaranteeing your loan, an annual MIP of 0.5% of the outstanding mortgage balance. This is added to your outstanding loan balance, so you don’t have to pay for the mortgage insurance while you’re still living in your home.

Servicing fee: The lender can charge a monthly servicing fee for managing your loan. The maximum monthly servicing fee is $30 for fixed- or adjustable-rate loans that reset annually, and $35 for adjustable-rate loans that reset monthly.

How Can You Compare Reverse Mortgage Lenders?

Choose the best reverse mortgage for your needs between competing reverse mortgage companies by considering these factors:

  • Loan types.
  • Costs.
  • Customer service ratings and reviews.

Shop reverse mortgage companies to find out which loan options they offer. For example, if you want an adjustable-rate line of credit, a lender that is limited to fixed-rate lump sum or tenure payments won’t be a good fit for you.

Compare reverse mortgage offers by getting rate quotes and identifying the reverse mortgage company with the lowest interest rates and fees. Be aware there’s some give and take so look at the bottom line as you compare reverse mortgage lenders.

“Often, the difference between lenders is where they put the costs,” Bell says. “Lenders that charge a lower interest rate are usually charging more upfront, while low-cost lenders may charge a higher interest rate. The right choice depends on when you want to pay: upfront or over the course of the loan.”

Consider how a reverse mortgage lender rates in customer satisfaction. Read lender reviews and check with the Better Business Bureau to see whether a lender has any complaints or comments from other borrowers.

Bell recommends that you use lenders who are members of the National Reverse Mortgage Lenders Association. “Our lenders have to follow a code of ethics for how they treat their customers. If a customer ever has an issue with a lender on our list, they can reach out to us and we can help resolve the dispute,” he says.

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