Reverse Mortgages: How To Decide If They Are Right For You
Almost everyone is familiar with a mortgage - a loan for buying a home. Can you imagine getting a home loan that could supplement your income and help you achieve other financial goals? You can create cash flow from your home's equity with a reverse mortgage.
An overview of reverse mortgages
Although a reverse mortgage on property is a type of loan, it does not work the same way as home purchase loans because they allow an eligible homeowner to borrow money. Suppose a homeowner is 62 or older and has a significant home equity conversion mortgage. In that case, they can borrow against it and receive funds in lump sums, fixed monthly payments, or lines of credit. Reverse home mortgage is different from forward mortgages because the homeowner doesn't have to make payments for the life of the loan.
According to federal regulations, reverse mortgage lenders are required to structure loans so that they don't surpass the home's value. Upon death, permanent relocation, or home sale, the entire loan balance is due and payable. As long as the mortgage insurance is in place, the borrower or borrower's estate won't have to pay the difference to the lender if the home's value falls or the borrower lives longer than expected.
Cash in equity for reverse mortgage property
The reverse mortgage home loan can provide seniors with little or no home equity with much-needed cash. The equity in their homes will be less than any outstanding home loans. Although these loans may suit some homeowners more than others, they can be costly and complicated.
Based on the National Reverse Mortgage Lenders Association, it is estimated that homeowners aged 62 and older held $11.2 trillion in equity in their homes as of the first quarter of 2022. The number has reached its highest level ever since the survey began in 2000, underscoring that home equity is a significant source of wealth for seniors.
When you sell your home and downsize or borrow against that equity, home equity becomes usable wealth. For retirees who have limited income and few assets, refinancing a reverse mortgage loan can offer a solution-especially for those with fixed income and few assets. However, reverse mortgage loans can also provide a solution for retirees who wish to diversify their income and reduce their investment, sequencing, and longevity risks. It is also possible to obtain cash through refinance reverse mortgages on investment property without paying monthly debt repayments.
Reverse mortgage process
In refinance reverse mortgages, the lender makes payments to the homeowner instead of the homeowner making payments to the lender. Payments are made in various ways, and the homeowner is only responsible for paying interest on the proceeds received. A homeowner is not required to pay a down payment since interest is rolled into the loan balance. Additionally, the homeowner retains ownership of the home. With time, the homeowner's debt increases, and the value of their home decreases.
Home equity serves as collateral for reverse mortgage loans as it does for forward mortgages. Reverse mortgage proceeds are used to repay principal, interest, mortgage insurance, and fees when a homeowner moves out of the house or dies. Proceeds from the sale beyond what was borrowed are paid to the homeowner if they are still alive or to the homeowner's estate if the homeowner has passed away. Depending on the circumstances, heirs may decide to pay off the reverse mortgage home loan to keep the property.
Different types of reverse mortgage on investment property
Reverse mortgage loans can be classified into three types. The home equity conversion mortgage (HECM) is one of the most known types of reverse mortgages. A HECM is the type of reverse mortgage on investment property you will get if your home value is below the conforming loan limit set by the Federal Housing Finance Agency. This article will discuss HECM reverse mortgages. Known as FHA reverse mortgages, these mortgages are available only through FHA-approved lenders.
However, jumbo reverse mortgages, also known as proprietary reverse mortgages, are available if your home is worth more than the value of the reverse mortgage on investment property.
- Lump sum: Upon closing the loan, you receive the entire amount. Fixed interest rates are available only with this option. There are five others with adjustable interest rates.
- Line of credit: Homeowners can borrow money as needed. In such a situation, homeowners only pay interest on the amount of credit they borrow.
- Equal monthly payments plus a line of credit : The lender gives steady monthly payments if one borrower settles in the home as a primary residence. Borrowers can access the line of credit whenever they need more money.
- Term payments plus a line of credit : Lenders usually offer borrowers a fixed payment schedule for a specific period, such as ten years. Borrowers can access this credit line during or after that period when they need additional funds.
- Equal monthly payments (annuity) : The lender will make steady payments to the borrower, provided that at least one borrower considers the home as their principal residence. This type of reverse mortgage is also known as a tenure plan.
- Term payments: Lenders give borrowers an equal monthly payment for a period, such as ten years.
HECMs can also purchase a different home from the one you currently reside in with a reverse mortgage. To qualify for a reverse mortgage on investment property, you usually need at least 50% equity in your home for what it is currently worth.
Why should you consider a reverse mortgage?
There are many similarities between reverse mortgage and home equity line of credit (HELOC) . In the same way as these loans, reverse mortgages on investment properties provide lump sums or lines of credit that can be accessed according to your home's value and the amount of debt you have repaid. When your primary residence is occupied, you won't have to make payments on a home equity loan or home equity line of credit.
Home equity can only be accessed without selling a home through a reverse mortgage for seniors if they meet the following criteria:
- Want to avoid monthly loan payments
- Cannot afford monthly loan payments
- Cannot qualify for a home equity loan or cash-out refinance due to low cash flow or a credit score that is below average
It is still possible for seniors to obtain other types of loans. Using an unsecured loan, for example, you can get a lump sum of cash without putting your house up as collateral. In that case, repayment would be required monthly.
What are the reverse mortgage requirements?
1. Property type
A reverse mortgage loan may be available to homeowners whose houses, condominiums, townhouses, or manufactured homes were built after June 15, 1976. Under FHA rules, cooperative housing owners are not eligible for reverse mortgage home loans since they don't own the property they live in. A corporation holds its shares. Refinance reverse mortgages are prohibited in co-ops in New York, where these residences are typical and can only be obtained in single- to four-family homes and condominiums.
2. Equity, age, and fees
Even though reverse mortgages do not have income or credit score requirements, there are still eligibility requirements. A homeowner must be at least 62 years old and own their home free and clear or have substantial equity (at least 50%). There are many fees borrowers must pay, including the origination fee, mortgage insurance premiums upfront, other fees associated with the closing process (e.g., loan servicing fees), and interest on the loan. Many of these items are regulated by the federal government.
To obtain a reverse mortgage home loan, prospective borrowers must complete a counseling session approved by the U.S. Department of Housing and Urban Development (HUD) . Reverse mortgage counseling sessions usually cost about $125 and last 90 minutes. They discuss the pros and cons of the loan, given your unique financial and personal circumstances. In this part of the document, you will learn how a refinance reverse mortgage can affect your Medicaid eligibility and Supplemental Security Income (SSI). As part of the counseling process, the counselor should also discuss the different ways the proceeds can be received.
4. Collateral Protection
As a reverse mortgage borrower, you must keep your property taxes and homeowners insurance current. In addition, you are responsible for paying homeowner's association fees if you have them and maintaining the home in excellent condition. Suppose you live in a long-term care facility for medical reasons for more than one year. In that case, you must repay the loan by selling the house, which is usually accomplished by selling the home.
Interest rates on reverse mortgages
There is only one reverse mortgage loan type with a fixed interest rate, the lump sum (single disbursement) reverse mortgage. In addition to the five options with fixed rates, the other five have adjustable rates. This makes sense since you borrow money over many years, not just once, and interest rates change frequently. It is common for variable-rate reverse mortgages to be indexed to a benchmark index, whether the Constant Maturity Treasury (CMT) index or another one.
In reverse mortgage loans, interest compounds over their lifetimes, and your credit score has no impact on the reverse mortgage rate or ability to qualify (but it may affect the lender's requirement that you set aside a Life Expectancy Set Aside account to cover your property taxes, homeowners insurance, and other property charges).
Lenders add a margin of one to three percentage points to one of the base rates. As a result, you will pay 4.5% for a reverse mortgage loan if your index rate is 2.5% and the lender's margin is 2%.
Is there a maximum reverse mortgage loan amount?
The payment plan and lender determine the number of proceeds you'll receive from reverse mortgages. As of Jan. 1, 2022, the maximum claim amount for a HECM is $970,800. Your HECM loan total will be based on the youngest borrower's age, the interest rate on the reverse mortgage loan, and the appraised value of your home.
In addition to paying mortgage premiums and interest, you must use part of the equity in your home for loan expenses. As a result, you cannot borrow any more than a certain percentage of what the property is worth.
In addition to knowing how much you can borrow, you may also want to know the following:
- Whether the borrower is single or married, the loan proceeds are determined by the age of the youngest borrower or the youngest spouse. This is true even if the younger spouse is not a borrower. If the youngest borrower is older, the reverse mortgage loan proceeds will be higher.
- Mortgage rates are lower when the loan amount is higher.
- You can borrow more money if your property's appraised value is higher.
- Reverse mortgages with strong financial assessments result in more proceeds since the lender will not withhold part of them for property taxes and homeowners insurance.
The initial principal limit determines how much you can borrow. Due to the government's decision in October 2017, the initial principal limit on reverse mortgages was lowered, making it harder for homeowners, especially younger ones, to qualify. Additionally, the changes help borrowers maintain more equity.
Due to a nearly doubled deficit in the mortgage insurance fund, the government lowered the limit as well as the premiums for insurance. In this fund, lenders are paid, and taxpayers are protected from loss on reverse mortgages.
When you choose a lump sum or a line of credit, you won't be able to borrow the full amount of your initial principal limit in the first year. For example, if you're paying off your forward mortgage, you can borrow up to 60%. You will never receive anything else if you select a lump sum. Choosing a line of credit will grow your credit line over time, but only if your line of credit has unused funds.
How to avoid reverse mortgage scams
Due to the potential profitability of reverse mortgages and the vulnerability of the target population, which includes both cognitively impaired borrowers as well as those desperately seeking financial help, scams are common. It is common for unscrupulous vendors and contractors to target seniors to help them obtain reverse mortgage loans to pay for home improvements - in other words, to make money from them. The vendor or contractor can steal the homeowner's money without fulfilling their promise of quality service.
The reverse mortgage has also been taken advantage of by relatives, caregivers, and financial advisors, who either use a power of attorney to obtain proceeds from home or convince seniors that they can only afford a reverse mortgage to buy an investment product like an annuity or whole life insurance policy. There is a high chance that this transaction will only serve the interests of the financial advisor, relative, or caregiver. The reverse mortgage scams listed above are just a few of the pitfalls homeowners can fall victim to.
Most effective ways to avoid reverse mortgage foreclosure
In addition to the possibility of foreclosure, reverse mortgage loans come with other risks. Although a reverse mortgage does not require the borrower to make mortgage payments, it does require the borrower to meet certain conditions. Lenders have the right to foreclose on mortgages if you don't meet these conditions.
In the event that you take out a reverse mortgage loan, you are required to live in and maintain the house. In such a situation, the borrower will not be able to recover the full amount it has extended to them if the home falls into disrepair.
In addition to paying property taxes and homeowners insurance, reverse mortgage borrowers must stay current with their mortgage payments. These requirements are imposed by the lender to protect its home interest in the home. If you stopped paying your property taxes, a local tax authority can seize your house. The lender's collateral is damaged if you do not have homeowners insurance and there is a house fire.
How much does a reverse mortgage cost?
Home equity conversion mortgages (HECMs), which is the most common type of reverse mortgage loan, involve several one-time fees and ongoing costs. A borrower must pay origination fees, closing costs, and mortgage insurance premiums with interest accruing on their loan balance.
When should you repay a reverse mortgage loan?
Reverse mortgages must be repaid if the borrower does any of the following:
- sells the house
- resides outside the home for over a year
- has passed away
- poor maintenance of the property
- stops paying your homeowners insurance or property taxes
If the borrowing spouse passes away, certain exceptions apply to eligible non-borrowing spouses who wish to live in the home.
Is it possible to owe more than the home is worth with a reverse mortgage?
You may have a loan balance that is higher than your home value. However, lenders can't pursue you or your heirs if the home turns out to be underwater on your loan's due date. When this happens, mortgage insurance premiums are put into a fund that compensates lenders.
Is it possible to refinance a reverse mortgage?
Refinancing a reverse mortgage loan is possible. It is recommended that refinancing a reverse mortgage be reserved for situations where the loan needs to be refinanced, more equity is required, or the interest rate is significantly reduced. It is due to the origination fee and upfront mortgage insurance premium, and closing costs.
The Bottom Line
Reverse mortgages can be helpful financial tools for senior homeowners who understand how they work and what tradeoffs they involve. A reverse mortgage is best for someone who spends the time to understand how it works. In that way, they won't be taken advantage of by unscrupulous reverse mortgage lenders or predatory scammers, will be able to make an informed decision even if they get a poor-quality reverse mortgage counselor, and won't get unpleasant surprises from the loan.
Borrowers would benefit from educating themselves about reverse mortgages to ensure they make the right choice about using their home equity. They should also shop around for a wide selection of the best reverse mortgage lenders rather than go with the first one that contacts them. It is not the federal government that sets reverse mortgage rates. Reverse mortgage lenders can have wide variations in their fees and rates.