A reverse mortgage (or home equity conversion, as it is sometimes called) involves selling the equity in a home while retaining the right to live in that home until death (a life estate). It turns a home's equity into regular cash payments.
However, there are age restrictions on this procedure, as well as other disadvantages that might outweigh the benefits for some people. Reverse mortgages can provide a source of supplemental income, but it's important to understand the terms and potential drawbacks, such as the impact on inheritance and increased debt. Consult with a financial advisor or legal counsel before making a decision
What is a Reverse Mortgage?
A reverse mortgage is a type of home equity loan that allows you to convert some of the equity in your home into cash but retain your home ownership. Reverse mortgages work like traditional mortgages, only in reverse. Rather than making a payment to your lender each month, the lender pays you through advances against your equity.
Unlike conventional home equity loans, most reverse mortgages do not require any repayment of principal, interest, or servicing fees for as long as you live in your home. Funds obtained from a reverse mortgage may be used for any purpose. This type of remortgage was originally designed so that seniors whose homes are paid for, or nearly so, can finance living expenses without having to sell their property.
To qualify for a reverse mortgage, you must own your home, occupy the home as a principal residence for more than six months out of a year, and be at least 62 years of age. If you have any debt against the home, you must either pay it off before getting a reverse mortgage or use an immediate cash advance from the reverse mortgage loan to pay it off.
The reverse mortgage funds may be paid to you in a lump sum, in monthly advances, through a line of credit, or in a combination of the three. The amount you are eligible to borrow generally is based on your age, the equity in your home, and the interest rate the lender is charging. The greatest cash amounts generally go to the oldest borrowers living in the homes of greatest value on loans with the lowest costs.
Because you retain title to your home, you also remain responsible for taxes, repairs, and maintenance. Failure to carry out these responsibilities could result in the loan becoming due and payable in full. Depending on the plan that you select, although you generally are not required to repay the loan as long as you live in the home, it becomes due with interest when you permanently move, sell your home, die, or reach the end of the pre-selected loan term.
The lender does not take the title to your home when you die, but your heirs must pay off the loan. The debt is usually repaid by refinancing the loan into a forward mortgage, if the heirs are eligible, or by using the proceeds from the sale of your home.
What Are the Different Types of Reverse Mortgages?
There are three reverse mortgage plans available: FHA-insured, lender-insured, and uninsured. All three plans are rising-debt loans. This means that the interest is added to the principal loan balance each month, resulting in a significant increase over time, in the amount of interest you will owe. All three plans charge loan origination fees and closing costs, the legal obligation to pay back the loan is limited by the value of the home at the time the loan is repaid, the loan is nontaxable, and in neither plan will Social Security or Medicare benefits be affected, although eligibility in Supplemental Security Income could be put at risk.
FHA-insured reverse mortgage
This plan offers all three payment options: lump sum, monthly advances, and line of credit. The FHA-insured reverse mortgage is not due as long as you live in your home. Interest is charged at an adjustable rate on your loan balance; any interest rate changes do not affect the monthly payment but, rather, how quickly the loan balance grows over time.
This plan permits changes in payment options at little cost and it protects you by guaranteeing that loan advances will continue to be made to you if the lender defaults. However, FHA-insured reverse mortgages may provide smaller loan advances than lender-insured plans and they likely will cost more than an uninsured plan.
Lender-insured reverse mortgage
These reverse mortgages offer monthly loan advances, or monthly loan advances plus a line of credit, for as long as you live in your home. Interest may be assessed at a fixed rate or an adjustable rate, and additional loan costs can include a mortgage insurance premium and other loan fees.
Loan advances from a lender-insured plan may be larger than those provided by FHA-insured plans, but the loan costs will most likely be greater. The lender-insured plan also may allow you to mortgage less than the full value of your home, thus preserving home equity for later use by you or your heirs. Some lender-insured plans include an annuity that continues making monthly payments to you, even if you sell the home. However, these payments may be taxable and could affect your eligibility for Supplemental Security Income.
Uninsured Reverse Mortgage
This reverse mortgage plan is dramatically different from both FHA-insured and lender-insured plans. An uninsured plan provides monthly loan advances for a fixed term only: a definite number of years that you select when you first take out the loan. Your loan balance becomes due and payable when the loan advances stop. Interest is usually set at a fixed interest rate and no mortgage insurance is required.
If you have short-term but substantial cash needs, the uninsured reverse mortgage can provide a greater monthly advance than the other plans. However, because you must pay back the loan by a specific date, you need to have a source of repayment. If you are unable to repay the loan, you may have to sell your home and move.
Difference Between a Reverse Mortgage and a HECM?
A HECM (Home Equity Conversion Mortgage) is a type of reverse mortgage backed by the Federal Housing Administration (FHA). In other words, a HECM is a specific kind of reverse mortgage. The key difference between a HECM and a reverse mortgage is that a HECM is a government-insured program, while a reverse mortgage may or may not be insured and can be offered by private lenders. HECMs have specific eligibility requirements, interest rates, and loan limits, and are subject to additional regulations, but they offer more protection for the borrower and their heirs.
What Type of Reverse Mortgage is the Least Expensive?
The type of reverse mortgage that is least expensive is typically a HECM (Home Equity Conversion Mortgage) loan, which is insured by the Federal Housing Administration (FHA). HECM loans have lower upfront costs and monthly mortgage insurance premiums compared to other types of reverse mortgages. However, it's important to compare the costs and fees of different reverse mortgage options and consider the specific needs and circumstances of the borrower before making a decision.
What Are Three Major Requirements to Qualify for a Reverse Mortgage?
To qualify for a reverse mortgage, there are typically three major requirements:
- Age: The borrower must be at least 62 years old.
- Homeownership: The borrower must own the property or have a significant amount of equity in it.
- Home type: The property must be the borrower's primary residence and must meet certain standards, such as being a single-family home, townhouse, or approved condominium.
It's important to note that reverse mortgage lenders may have additional requirements, such as a minimum credit score or proof of income, and that the terms of the loan can vary depending on the lender and the borrower's specific circumstances.
What Do You Have to Pay?
Do not sign a service agreement for anyone to help you find a reverse mortgage lender or apply for a loan. This help is available at little or no cost from a HUD-approved housing counseling agency or your nearest HUD office. Applying for a reverse mortgage should only include the cost of an appraisal and a credit report.
The best way to compare the cost of reverse mortgages is to use the Total Annual Loan Cost (TALC) rates that the federal Truth-In-Lending law (Regulation Z) requires lenders to disclose to you. TALC rates are generally greatest in the first five years of a reverse mortgage and grow smaller over time.
They can be especially high in the first years of a loan if you select monthly advances or use a small part of a credit line. Ask for TALC rates early in your decision-making, and before you sign a contract check the repayment conditions to be sure you understand all the reasons for any cost differences.
How Do You Pay Back a Reverse Mortgage?
A reverse mortgage is typically paid back when the borrower sells the home, permanently moves out or passes away. The loan amount, including interest and fees, is due and payable at that time and is typically paid back from the proceeds of the sale of the home. If the sale proceeds are not enough to pay off the full amount of the loan, the borrower or their estate is not responsible for the deficiency. It's important to understand the terms of the reverse mortgage and to plan for the eventual repayment of the loan, as it can impact the inheritance and equity in the home.
What is the Downside to a Reverse Mortgage?
A reverse mortgage can provide homeowners with supplemental income, but it is important to understand the potential disadvantages and risks before making a commitment. Among the disadvantages of reverse mortgages are:
- Reduced inheritance: The loan amount, interest, and fees will reduce the borrower's home's equity, potentially affecting the borrower's heirs' inheritance.
- Required property maintenance: The borrower is still responsible for property maintenance, property tax payments, and insurance coverage.
- Upfront costs: Reverse mortgages typically have greater up-front expenses than conventional mortgages, including loan origination fees, appraisal fees, and mortgage insurance premiums.
- Increased debt: Over time, the loan amount and associated interest and fees can grow, thereby increasing the borrower's total debt.
- Reduced eligibility for government benefits: Depending on the number of funds received from the reverse mortgage, the borrower's eligibility for government benefits such as Medicaid may be reduced.
If you are age 62 or older and are house-rich and cash-poor, a reserve mortgage may be an option to help increase your income. However, because your home is such a valuable asset, you may want to consult with your family, attorney, or financial adviser before applying for a reverse mortgage. Knowing your rights and responsibilities as a borrower could help to minimize your financial risks and avoid any threat of foreclosure or loss of income.