Reverse Mortgage Fees: 5 Fees to Look Out For (With Estimates)
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Summary:
Reverse mortgages offer a unique financial solution for seniors, unlocking home equity without a sale. However, understanding the encompassing fees, both initial and ongoing, is crucial. This article elaborates on the actual costs, contrasting reverse mortgages with traditional ones, and provides tips for prospective borrowers to shop wisely.
Reverse mortgages present a viable solution for homeowners, especially seniors, who wish to leverage their home’s equity without having to sell. However, like any other financial product, it’s imperative to understand the associated costs. This article aims to dissect these costs and offer a clearer understanding to prospective borrowers.
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What is a reverse mortgage?
A reverse mortgage is a loan specifically designed for seniors 62 and over (55 and over for some non-government products). The reverse mortgage allows seniors to access part of the equity they have accumulated in their homes. Equity is defined as the difference between what the home is currently worth and what the senior owes on the home. For example, a senior who owns a home valued at $400,000 and has $50,000 remaining on their mortgage has $350,000 ($400,000 Value – $50,000 remaining owed.)
The senior can then convert a portion of the $350,000 into cash without having to sell their home or make monthly mortgage payments. The reverse mortgage is known by its legal name, the Home Equity Conversion Mortgage or HECM. This type of mortgage is insured by the Federal Housing Administration (FHA).
Understanding reverse mortgage fees
Reverse mortgages, primarily aimed at seniors, come with substantial fees. To start with, there is the origination fee, which fluctuates based on the loan provider and the home’s value. Standard closing costs such as appraisal fees, title insurance, and inspection fees are also part of the initial expenses.
The ongoing costs include a mortgage insurance premium (both an upfront cost and an annual premium under the Federal Housing Administration’s Home Equity Conversion Mortgage program), a monthly service fee, and interest that accrues over the loan’s term.
Mortgage insurance premium explained
The biggest thing that most people see on a reverse mortgage and proceed to determine that it is a ‘bad’ deal is the fees and, more specifically, the mortgage insurance premium,” explains Jarred Talmadge, a 28-year veteran of the mortgage industry and author of “My Parents Are Doing What? An Adult Child’s Guide to Reverse Mortgage.”
“The reason for this is the mortgage insurance premium is usually 2% of the home value. So, a $400,000 home with a $180,000 reverse mortgage would have an initial mortgage insurance premium of $8000. Usually, there are additional third-party fees of around $3000. This covers things like the title insurance and closing, the appraisal, recording fees, and other third-party fees that are associated with the loan. Finally, on most reverse mortgages, there is also an origination fee of between 0 and $6000. FHA caps the origination fees at $6000 based on two percent of the home’s value.”
“These numbers can change drastically from state to state, depending on what they charge,” adds Talmadge. For example, Florida has a transfer tax that could add thousands of dollars to the transactions. Other states have other requirements like waiting periods or capped fee amounts.”
Now, in terms of fees, many people think this is expensive. They are certainly not cheap, but the fees for a reverse mortgage are in line with any other FHA Product on the market. However, the FHA insurance, this loan offers more protection to seniors against a depreciating market than any other product out there.
Estimating the actual cost of a reverse mortgage
A reverse mortgage’s actual cost can vary significantly based on numerous factors, including the home’s value, the homeowner’s age, interest rates, and the chosen lender. Let’s take a house worth $400,000 as an example to provide a rough estimate of the costs associated with a reverse mortgage.
The table below outlines the estimated ranges for key fees associated with a reverse mortgage for a home valued at $400,000.
The table below outlines the estimated ranges for key fees associated with a reverse mortgage for a home valued at $400,000.
| Fee | Estimated Cost | Description |
|---|---|---|
| Origination Fee | $2,000 – $6,000 | Fees paid to the lender for processing the reverse mortgage |
| Closing Costs | $2,500 – $5,000 | Includes appraisal fees, title insurance, and inspection fees |
| Initial Mortgage Insurance Premium | $8,000 (2% of home value) | Upfront mortgage insurance premium |
| Annual Mortgage Insurance Premium | $800 (0.5% of outstanding balance) | Annual premium based on the outstanding loan balance |
| Service Fee | $30 – $35 per month | Monthly fee for loan servicing |
| Interest | 6% – 9% annually | Accumulates over the loan’s duration, based on current rates |
Note that the table above also includes the service fee and interest. The interest rate is estimated to range between 6% to 9% annually, though the exact rate will depend on the lender and prevailing market conditions. The service fee is a monthly charge for loan servicing, which will also accumulate over the loan’s duration. These ongoing costs, along with the annual mortgage insurance premium, will contribute to the growing loan balance over time.
What would the cost of interest be?
Estimating the total cost of interest over the life of a reverse mortgage can be complex as it depends on several variables, such as the interest rate, the amount borrowed, the loan term, and the payment options selected. However, I can provide a simplified example to give a rough idea of how the interest could accumulate over time.
Assuming a homeowner borrows $200,000 from their $400,000 home, and doesn’t make any payments during the loan term, the interest would accumulate on the loan balance.
Using the formula for compound interest:
where:
- is the future value of the investment/loan, including interest,
- is the principal investment amount (the initial deposit or loan amount),
- is the annual interest rate (as a decimal),
- is the number of times that interest is compounded per year,
- is the number of years the money is invested or borrowed for.
Assuming the interest is compounded monthly (), and the loan term is 10 years (), the formula becomes:
Now, plugging in the interest rates of 6%, 7.5% (the midpoint), and 9%:
6% interest rate:
7.5% interest rate:
9% interest rate:
The total cost of interest would, therefore range from approximately $158,600 to $291,400 over a 10-year period, depending on the exact interest rate.
Reverse mortgages Vs. traditional mortgages
Unlike a traditional mortgage, where monthly payments are made to the lender, reverse mortgages see the lender paying the borrower. The loan balance increases over time, being settled when the homeowner sells, relocates permanently, or passes away. While the interest rates for reverse mortgages tend to be higher, the key divergence lies in the payment structure and purpose: traditional mortgages aid in home purchases, while reverse mortgages convert a portion of home equity into cash.
Unlike traditional mortgages, where a borrower can get up to a specific percentage, sixty, seventy, or eighty percent, a reverse mortgage doesn’t work this way. The amount the client can borrow is based on their age. So, a 62-year-old person can’t get as much as say an 80-year-old person. “The closer in age the person is to 62 years old, the less they can borrow. The amount they can borrow is also tied to the current interest rates and margins that are available. For example, in the current market in 2023, the rule of thumb is about one-third of their equity or thirty-three percent of the value of their home,” says Talmadge.
“This is because interest rates are in the sevens. Two years ago, when interest rates were in the threes and fours, then a client could usually borrow up to fifty percent of the home’s value. These are determined by actuarial tables put out by FHA. The other factor is the lending limit set by FHA. In most places, that number is at or near a million dollars, so it largely doesn’t affect most people’s calculations. But FHA will not loan more than one million dollars and change on a reverse mortgage at this time.”
Shopping for a reverse mortgage
Education is key
Ensuring a comprehensive understanding of the terms, conditions, and long-term implications is crucial. Prospective borrowers should take advantage of free counseling sessions offered by the U.S. Department of Housing and Urban Development (HUD).
Comparison shopping
Just as with any significant financial product, shopping around is vital. Different lenders propose varying terms, and minor differences in fees or interest rates can have a notable impact over the loan’s lifespan.
Having said that, comparison shopping is not as important with reverse mortgages as with traditional “forward” mortgages. “The difference between reverse mortgages versus forward mortgages is that with forward mortgages, you can call and request a rate based on your situation, and you might get different rates from different lenders. So it’s worth shopping around for. But with reverse mortgages, because most of the market is set by FHA, so too are the rates,” comments Talmadage. “You might be able to shop around for the difference of 1/8 of a point on the overall deal. Maybe a ¼ point if the lenders are desperate for business, but beyond that, you aren’t going to see different rates or terms. With a reverse mortgage, the difference is how long it takes to get the deal completed. Some can take as little as ten days, and I’ve seen lenders that take more than 90 days to complete.”
This free tool will help you compare reverse mortgage companies.
When does a reverse mortgage make sense?
A reverse mortgage might be a viable solution under certain circumstances, especially for seniors who have substantial equity in their homes but limited cash flow. Here are some scenarios where a reverse mortgage might make sense:
- Supplemental Income: If you’re retired and looking for ways to supplement your income, a reverse mortgage can provide additional funds to cover daily living expenses, healthcare costs, or other financial needs.
- Eliminate Existing Mortgage: If you have an existing traditional mortgage, a reverse mortgage can help eliminate those monthly mortgage payments, although you’ll still be responsible for property taxes, insurance, and maintenance.
- Deferred Social Security Benefits: By using a reverse mortgage, you might be able to defer claiming Social Security benefits until a later age, which can increase your monthly benefit amount.
- Home Improvements: If your home needs significant repairs or improvements, a reverse mortgage can provide the necessary funds without requiring you to dip into your savings.
- Financial Cushion: Having a financial cushion for unexpected expenses is crucial, and a reverse mortgage can provide a line of credit for emergencies or unforeseen costs.
- Estate Planning: Some individuals use a reverse mortgage as part of a comprehensive estate planning strategy to increase liquidity, manage taxes, or address other financial goals.
However, a reverse mortgage isn’t for everyone. It’s essential to consult with a financial advisor to understand the implications fully and to explore other financial options. Making an informed decision will ensure that you’re taking the right steps toward securing your financial future.
Reverse mortgage fees compared to traditional mortgages, HELOCs, and home equity agreements
When considering a reverse mortgage, it’s crucial to compare its fees and costs to other financial products such as traditional mortgages, Home Equity Lines of Credit (HELOCs), and home equity agreements. As illustrated in the table above, reverse mortgages tend to have higher origination and closing costs compared to other options. Moreover, they come with an added expense of mortgage insurance premiums, both upfront and annually. The interest rates associated with reverse mortgages are also typically higher than those of standard mortgages and HELOCs. This can significantly impact the total cost of the loan over time, making reverse mortgages a more expensive option in the long run.
| Type of Loan/Agreement | Origination Fee | Closing Costs | Monthly Service Fee | Mortgage Insurance |
|---|---|---|---|---|
| Reverse Mortgage | $2,000 – $6,000 | $2,500 – $5,000 | $30 – $35 | Upfront and annual MIP |
| Standard Mortgage | 0% – 1% of loan amount | 2% – 5% of loan amount | N/A | Usually required if down payment < 20% |
| Home Equity Line of Credit (HELOC) | 0% – 2% of credit limit | $0 – $1,000 | N/A | N/A |
| Home Equity Agreement | N/A | Varies | N/A | N/A |
On the other hand, traditional mortgages and HELOCs generally have lower origination and closing costs and offer more favorable interest rates. However, they require the borrower to have a good credit score and a stable income, which may not be feasible for retirees. Home equity agreements, another alternative, do not entail any monthly payments or interest charges, but they require sharing a portion of your home’s future value appreciation with the agreement provider. Each of these options has its own set of advantages and disadvantages, and the right choice would depend on your financial situation, your home equity, and your long-term financial goals. Consulting with a financial advisor can provide a clearer understanding and help in making an informed decision.
How does a reverse mortgage work?
“A client or couple must be at least sixty-two years old or older, as determined by the youngest of the borrowers,” says Jarred Talmadge. “When a senior takes out a reverse mortgage, they have multiple options on how they receive payments. They can receive payments as a lump sum or as a line of credit, which they can use at any time. They can also elect to take payments monthly for either a fixed period of time, or for the rest of their life.”
How does a reverse mortgage differ from a regular mortgage?
“The difference with a reverse mortgage is that the client is not required to make monthly mortgage payments as long as they meet the criteria of the loan, which for FHA loans means, at least one person of the couple must live in the home as a primary residence for six months and one day a year, to meet occupancy requirements,” explains Talmadge, who was national sales manage for AAG, Simple Reverse Lending, and Longbridge Financial.
“They must maintain homeowner’s insurance on the home, and they must pay the property taxes on the home. These items can sometimes be added to the loan in the form of a Life Expectancy Set Aside, which is just another way of calling it an escrow account for taxes and insurance. The reason this is confusing is because in order to do a LESA or Life Expectancy Set Aside, the money will be deducted from the amount the borrower can take out.”
Reverse mortgage scenarios
To illustrate, on a $400,000 home value, the client could currently take out approximately forty-five percent of the value. In this case, $180,000. If the client owes $50,000, then that needs to be taken from the amount the client can borrow. $180,000 – $50,000. That would leave $130,000. If the client agreed to a Life Expectancy Set Aside, it could be $30,000 or more. Figure the amount of taxes per year, plus the amount of homeowner’s insurance per year, and then multiply by the number of years of their life expectancy. (This is automatically calculated using insurance tables, but usually to age 95 or so.)
This would mean the client would have $30,000 parked in an escrow account and would be paid to the taxes and insurance yearly. That would also mean if the client had $130,000 in available cash, you would deduct $30,000, and the client would then still have $100,000 available to them.
In this example, the client could borrow no more than $180,000 (from earlier) on a home valued at $400,000. Now, this means the client has approximately $220,000 in equity still available in the home.
Now, this is key to understanding the difference with a reverse mortgage. Over the years, the home value will go up. Let’s say $450,000. And the way the reverse mortgage works, no principal and interest payments are necessary, so the amount of money owed over that same period may increase from $180,000 to, let’s say, $230,000. Then, both seniors pass away, leaving the home to their children.
Scenario 1: the home increases in value
Let’s say the home is now worth $450,000 and the amount due on the mortgage is $230,000. The heirs can choose to sell the home. If they do that, they sell the home for $450,000. They pay off the mortgage for $230,000 just like they would with any other mortgage. The remaining equity, $220,000 ($450,000 – $230,000) is theirs to do with what they please. That’s it. That’s how a reverse mortgage works.
Scenario 2: the home loses value
But what happens if, during that time, the home lost value and became worth only $200,000? Let’s say the home is worth $200,000, and the mortgage is $230,000. The important thing to remember is that heirs do not inherit the debt. Here’s how that works and why FHA is so critical in this process. If in the event this happens, the heirs can purchase the home for 95% of whichever is less, the appraised value or what is owed. So, let’s say the home appraises for $200,000. The heirs can choose to refinance or sell the home for 95% of the lesser value ($200,000 X 95%) $190,000. The remaining money is paid back by FHA because there was mortgage insurance required on the deal. (More about this in fees). Or the heirs could choose to walk away, leave the home to the bank and let them deal with it. There are no financial repercussions to the heirs in any way.
A reverse mortgage is certainly not for everyone, but it can provide financial flexibility to seniors who want to access their home equity to supplement their income, pay for health care, or finance something else.
Key takeaways
- Understanding both upfront and ongoing costs is crucial before opting for a reverse mortgage.
- Education, comparison shopping, and professional guidance can significantly aid in making an informed decision.
- While reverse mortgages provide financial relief, they come with high upfront costs and accumulating interest, which could impact your financial health in the long run.
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Andrew is the Content Director for SuperMoney, a Certified Financial Planner®, and a Certified Personal Finance Counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.
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