If you are nearing retirement and a bit worried about your liquid assets, a reverse mortgage may be able to help supplement your income.
The U.S. Department of Housing and Urban Development (HUD) launched the Home Equity Conversion Mortgage (HECM) program in 1990 and has since extended over 1 million federally-insured reverse mortgages to Americans 62 years of age and older.
What is a reverse mortgage and how does it work?
A reverse mortgage is a loan for qualified borrowers who want to convert part of the equity in their home into cash (usually tax-free), which can then be used for any purpose.
The borrower keeps the title of the house and is still responsible for paying property taxes, utilities, home insurance, maintenance, and other related costs.
Different options are available for loan disbursements, such as receiving a lump sum, a line of credit, or monthly payments. Interest is added to the loan each month, so the amount grows over time.
The borrower doesn’t have to make any payments on the loan while he or she is living in the house. The balance will become due if they pass away, stop living in the home for at least 12 months, or sell it.
When one of these events occur, the borrower can pay back the loan with cash, by selling the house, or by refinancing.
Andrina Valdes, Division President at Cornerstone Home Lending, Inc., says, “One of the most convenient aspects of a reverse mortgage is that, as long as the borrower continues to meet requirements (living in the home, paying property taxes, etc.), no monthly payment is required on the loan.”
She adds, “The borrower certainly has the option to make monthly payments, which they may do if they plan to leave the house to family members in their will, but the borrower is not obligated to make those payments.”
Types of reverse mortgages
Next, let’s look at the three types of reverse mortgages on offer.
Single-purpose reverse mortgages (property tax deferral programs)
Single-purpose reverse mortgages are like regular reverse mortgages, but have the added requirement that the borrower must use the loan to pay for a specific approved item, such as a home repair or property taxes.
This type of loan is offered by select non-profit organizations and state and local governments but is not widely available. In fact, they make up only a small portion of reverse mortgages.
Each state can set requirements for the loan and may not disburse cash to the borrower directly. Instead, they sometimes pay for the item directly.
These mortgages are not federally insured and are often only available for older homeowners with low to moderate incomes. Lastly, interest and fees on this type of reverse mortgage are typically lower than other types.
Proprietary reverse mortgages (jumbo reverse mortgages)
Proprietary reverse mortgages are designed for senior borrowers with home values that exceed the maximum limit set by HECM for their state.
Being that the loan amounts are higher and come with more risk, the loans also usually have higher interest rates. These are typically insured by private lenders and banks.
Home Equity Conversion Mortgages (HECMs)
Most reverse mortgages (about 90%) are HECMs, which are insured by the Federal Housing Administration (FHA). These are available to borrowers who live in homes with values below the maximum limit, which, according to HUD, is $679,650 for the 2018 calendar year.
Following are the HECM requirements for reverse mortgage borrowers:
- Be at least 62 years old
- Own home outright or have a low remaining balance that can be paid off at closing using the reverse mortgage loan
- Have resources to pay for the ongoing costs of maintaining the home (insurance, taxes, etc.)
- Live in the home as their primary residence
- Complete financial counseling by a HUD-certified professional
- Meet financial eligibility obligations set by the HUD
HECM home requirements:
A borrower’s home can be a single-family home, a two-to-four unit home where the borrower lives in one unit, or a HUD-approved manufactured home or condo that meets FHA requirements.
HECM loan amounts:
The amount you can borrow will depend on the interest rate, the age of the youngest eligible non-borrowing spouse or borrower, the appraised value of the home, and the interest rate – but it can’t exceed the maximum limit of $679,650. The older you are, the more you can borrow.
You can get this type of reverse mortgage through any FHA-approved lender.
When it comes to getting the money, there are various options which include:
- Lump sum option: Receive a single lump sum disbursement when the mortgage closes (available on fixed-rate loans)
- Equity line option: Gain access to the loan as a credit line (available with adjustable interest rates)
- Tenure option: Receive equal monthly payments as long as one borrower is living in the house as their principal residence (available with adjustable interest rates)
- Term option: Receive equal monthly payments for a fixed period (available with adjustable interest rates)
- Combination option: There are also options to combine a line of credit and monthly payments as long as you stay in the home or for a fixed period (available with adjustable interest rates)
Casey Fleming, mortgage advisor and author of The Loan Guide: How to Get the Best Possible Mortgage, created this chart to help borrowers decide which payment option is best for them:
While HECMs are the most common of the reverse mortgage types, there are other options in case you can’t get approved or have a home with a value that exceeds the maximum loan limit.
Next, let’s look at the costs.
Reverse mortgage costs
There are often origination fees, closing costs, servicing fees, and interest involved with reverse mortgages. With a HECM, you will be required to get FHA mortgage insurance which has an upfront and annual cost.
The initial mortgage insurance premium is 2%, which can be financed as part of your loan. The annual mortgage insurance premium will end up equaling 0.5% of the outstanding mortgage balance.
HECM closing costs can include the costs for inspections, surveys, mortgage taxes, appraisals, title searches, recording fees, and more. HECM origination fees compensate the lender for processing your loan.
Lenders can charge $2,500 or 2% of the first $200,000 of your home’s value (whichever is greater) plus 1% of the amount over $200,000, up to $6,000. Lenders may also charge servicing fees over the life of the loan up to $35 per month.
Lastly, interest will accrue each month and will be added to the amount you owe. Fixed and adjustable rates are available.
As for writing off the interest on your taxes, it won’t become tax-deductible until after you pay it, which is usually when the loan is paid off in full.
When shopping around for a lender, be sure to find out about all the costs involved and compare at least three options.
Who can get a reverse mortgage?
Reverse mortgage age limits can vary by the type of reverse mortgage you get. For HECMs, the minimum age is 62. There will be other requirements as well, which can vary by lender and mortgage type.
Before applying, be sure to read through all of the eligibility requirements.
What happens to a reverse mortgage when you die or sell your home?
If you pass away and are the last surviving borrower or eligible non-borrowing spouse on a reverse mortgage, the loan balance and interest would become due. Your beneficiary would be responsible for paying it in full.
To do so, they will have to put your home on the market, sell it, and use the proceeds to pay it off, or pay off the loan in another way and keep the home. Beneficiaries have 30 days to make a decision and six months to complete the transaction.
Similarly, if you sell your home, the loan balance and accumulated interest will become due, and you will need to pay it.
Reverse mortgages aren’t the only option. If you need more cash, you could also consider:
- Home equity loans: Cash out your home equity in a loan with monthly repayments over a set term
- Home equity lines of credit: Gain access to your home equity in the form of a credit line which you can make withdrawals from as needed over a set period
- Refinancing your home: Get a new loan to replace your existing home loan and potentially lower your costs
- Personal loans: Get a loan based on your credit
- Downsizing: Sell your home and move into a smaller home to reduce house debt
- Lower your expenses and get debt help
It’s wise to review all of your options so you can make an informed decision on which will be most beneficial.
So, when is a reverse mortgage a good idea?
A reverse mortgage makes sense if a qualified borrower:
- Is planning to stay in their home for the foreseeable future
- Isn’t concerned about passing the home to heirs
- Needs extra money for living expenses
Beyond that, you’ll want to make sure it provides the most value when compared to every other option.
“Reverse mortgages are often misunderstood by Americans, resulting in a strong negative bias toward this loan type. But the reality is that a reverse mortgage could be an excellent source of tax-free income for older homeowners who may be limited on funds,” says Valdes.