What is a Reverse Mortgage?

Reverse mortgages are one way senior homeowners who are 62 years and older may be able to tap the home equity.  A reverse mortgage gives the homeowner money they need without having to leave the house and without having to repay the loan until the owner dies, the home is sold, or the house is no longer used as the primary residence.  As such, a reverse mortgage could be a good alternative to selling your home, home equity loan, and HELOC.

How Does a Reverse Mortgage Work

Reverse mortgage loans let you borrow money against your home equity.  No payment is required as long as you live in your home. When the last living borrower dies, sells the home, or permanently moves away, the loan must be repaid in full along with all interest and other charges. The remaining equity in your home, if any, belongs to you or your heirs.  However, you or your heirs will never owe more than the home’s value.

Regular Mortgages versus Reverse Mortgages

With a regular mortgage, you build up your home equity with each payment you make to the lender.  With a reverse mortgage, your home equity decreases each time the lender gives you money.

In a reverse mortgage, the homeowner makes no payments and all interest is added to the lien on the property.  As such, the amount you owe grows larger and your equity ownership grows smaller over time.  However, it’s important to note that as a reverse mortgage borrower, you continue to own your home. So you are still responsible for the property taxes, insurance, and maintenance of the property. Your loan could become due and payable in full if you fail to carry out these responsibilities.

Who is Eligible for a Reverse Mortgage

Borrowers must be at least 62 years of age for most reverse mortgages and must occupy the home as a principal residence. Some programs require that you own your home outright, or have a low mortgage balance that can be paid off at closing with proceeds from the reverse loan.

All reverse mortgage programs accept single family home. Some programs also accept 2-4 family home as long as the owner occupies one of the units, along with some condominiums, cooperatives, planned unit developments, and manufactured homes. Mobile homes are generally not eligible.

Unlike traditional second mortgage, or a home equity line of credit, a reverse mortgage is available regardless of your current income, your debt-to-income ratio, and credit score.  The amount you can borrow depends only on your age, the current interest rate, and the appraised value of your home.

What You Get from a Reverse Mortgage Loan

When you take out a reverse mortgage loan, you have three options of getting your money:

• Line of credit, which let you take money from your reverse mortgage account as you need it.  This is similar to HELOC, but without immediate loan repayment requirement.
• Regular monthly payments, which is similar to monthly mortgage payment in reverse or an annuity.
• Lump sum payment, in which you get the total amount of the loan upfront.

Some lenders will also let you choose any combination of these payment plans. The amount of cash you can get from a reverse mortgage generally depends on your age, your home’s value, location, and the cost of the loan.  Older borrowers with more equity in the home generally qualify for a larger loan.

Reverse Mortgage Lenders

There two main types of reverse mortgage lenders — private sector and public sector:

• Private sector reverse mortgage lenders are banks, mortgage companies, and savings associations. These private loans can be used for any purpose, but are generally more expensive.
• Public sector reverse mortgage lenders are your federal, state and local governments. For example, the HUD’s Federal Housing Administration (FHA) offers a reverse mortgage program called the Home Equity Conversion Mortgage (HECM).  HECM is federally insured and often provide much greater loan advances than other reverse mortgages. However, there are usually some restrictions on the use of these public sector loans — e.g., must be used to pay for home repairs or property taxes.

The Costs of Reverse Mortgages

The total cost of your reverse mortgage depends on your lender.  In general, a reverse mortgage will cost you less with public sector lender than a private sector lender.  Commercial reverse mortgages are usually very expensive and include a variety of costs — i.e., higher interest rate, application fee, appraisal fee, credit report fee, origination fee, insurance, monthly servicing fee, and other closing costs.  These costs usually can be paid as part of the loan, which mean your loan balance will increase more than what you get in cash.

In addition to the obvious, there are hidden costs that you must consider:

• Appreciation – Some reverse mortgages come with an equity-appreciation or an equity-share provision.  This usually gives you slightly higher advances, but you could lose some or all of the home price appreciation.
• Unexpected changes — If you are forced to sell your home or have to move to a long-term care facility, you’ll be forced to end your contract and repay the loan in full.
• Counseling – There are also unscrupulous lenders or advisors that will charge you expensive counseling fee to walk you through the process of getting a reverse mortgage.  If you need counseling, find an independent HUD-approved expert or hire a fee-based financial planner or CPA — not a counselor affiliated with a bank or lender.
• Federally insured loan – In most cases the best choice is to work with HUD’s FHA through the HECM program.  When you work with the FHA, your reverse mortgage is federally insured and your are guaranteed that the loan advances will continue, even if your lender goes bankrupt or your home’s value drops.

Reverse Mortgage Calculator

One way to better understand the costs is to use a reverse mortgage calculator, for instance you can use calculators below to understand the relationship between your home value, reverse mortgage debt, and the loss of equity.

• AARP
• NRMLA

Advantages and Disadvantages of Reverse Mortgages

The article wouldn’t be complete without covering the major pros and cons of reverse mortgages.

The Pluses of Reverse Mortgages

• No immediate loan repayment (probably the biggest factor for borrowers considering a reverse mortgage)
• Readily available source of cash
• Because a reverse mortgage is a loan and not income:
  • No income taxes due on the money you received
  • No reduction of Social Security benefits
• No capital gains tax because there’s no sales involved

The Minuses of Reverse Mortgages

• Reduces equity in your home
• Loan must be repaid when the termination conditions are met
• Depending on the contract, you may not get the full benefit from additional increases in the value of your home
• High interest rates and closing costs
• Reduces estate to leave your heirs

Summary

Just like any other financial products, a reverse mortgage could help you achieve your goals and give you the financial freedom needed — or it could be bad for your finances.  The only way you can make better decision is to learn as much as possible about various financial products, their pluses and minuses, and chose the ones that best fit your needs.

More Reverse Mortgages Information

The subject of reverse mortgages is rather complicated, especially when you are dealing with different lenders who offer different options and have different requirements.  This article only covered the basics and you should seek out additional information.  Here are some resources that you can start with:

• U.S. Department of Housing and Urban Development — search for “reverse mortgages”
• FTC: Reverse Mortgages

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