Quite simply, a reverse mortgage is a loan that pays the borrower instead of the borrower paying the loan.
Also known as a Home Equity Conversion Mortgage, or HECM (pronounced HECK-um), reverse mortgages are only for homeowners age 62 and older. The purpose of a reverse mortgage is to help older homeowners keep their home, reduce monthly expenses, and/or pay off debts.
A reverse mortgage requires no monthly payments by the borrower. The loan does not have to be paid back until the borrower dies, the home is sold, or the borrower moves out. Upon these circumstances, the original loan balance plus accrued interest is paid back.
How Reverse Mortgages Help
Some older homeowners are “house-rich and cash-poor” meaning they have considerable equity in the home, but not enough regular income to qualify for any other type of refinance.
A reverse mortgage provides funds to a homeowner based upon available equity in the property and not on credit or employment. So a reverse mortgage applicant can have zero income, high debt, and very bad credit, and still potentially qualify. This is a big advantage of reverse mortgages over any other type of loan.
Types of Reverse Mortgages
This program allows the borrower to take payment in the form of a line of credit or equal monthly payments, or a combination of different kinds of payments. See “How Reverse Mortgage Proceeds are Paid to the Borrower” below.
As of April 1, 2013, this product is only available as an adjustable rate mortgage. Prior to this date, borrowers could take out a lump sum with a fixed rate. For a lump sum fixed rate withdrawal, borrowers now must use the HECM Saver.
The HECM Saver has a low upfront mortgage insurance premium (MIP) of .01%. That’s only $30 on a $300,000 loan, compared to $6000 (2%) upfront MIP on a HECM Standard.
This product allows a fixed rate lump sum to be taken at closing, rather than monthly payments or a line of credit. However, the amount of money available with a HECM Saver is reduced compared to a HECM Standard. This may be a great option for those with a lot of equity, want a fixed rate reverse mortgage, and want low fees.
Reverse Mortgages to Buy a Home
A reverse mortgage can also be used to buy a home. The borrower opens a reverse mortgage for the home, then never has a payment. It’s essentially like receiving the reverse mortgage lump sum payment upfront (see next section). The difference is that instead of receiving cash, the funds go toward paying the purchase price of the home. The HECM for purchase option requires a significant down payment, usually at least 40%.
The advantage to using a reverse mortgage in this way is that a borrower can downsize, buy a newer home that requires less maintenance, or otherwise buy a more suitable home, all while ensuring the mortgage payments won’t be a factor during retirement.
This reverse mortgage option, like all reverse mortgage types, is best suited for borrowers who plan to stay in the home until they pass away. Selling a home shortly after buying it with a reverse mortgage can be costly. But keeping the home long term can prove to be a wise way to own property in retirement.
How Reverse Mortgage Proceeds are Paid to the Borrower
Term. Equal payments over a specific amount of time. For instance, payments of $100 per month over 20 years.
Tenure. Equal monthly payments as long as the borrower lives in the home. The payment amount is determined by equity in the property and life expectancy of the youngest borrower.
Line of Credit. The borrower may withdraw any amount of money whenever they desire, until their maximum line of credit is exhausted.
Modified Term. The combination of a line of credit and monthly payments for a certain amount of months.
Modified Tenure. The combination of a line of credit and monthly payments for as long as the borrowers live in the home
Lump Sum. This option is only available with the HECM Saver. One important aspect of this option is that once the lump sum is taken, no further cash is available. The borrower must make sure they have adequate income to pay taxes, insurance, and HOA dues on the property, as well as other living expenses.
Reverse Mortgage Guidelines
Amount of Money Available
The amount of money the borrower can receive is based on the age of the youngest borrower in the home, the value of the home, current interest rates, and the upfront costs. The FHA uses calculations based on the borrower’s life expectancy, therefore the older the borrower, the more money potentially available.
For example, a 72 year old reverse mortgage borrower who owns his home valued at $400,000 free and clear is eligible for a reverse loan of approximately $250,000 after closing costs are deducted. A borrower who is 62 applying for the same reverse mortgage program is eligible for an amount closer to $230,000.
Obviously, the value of the home and any existing liens on the property greatly affect available cash as well.
In previous years, no income analysis was performed on reverse mortgages. But starting January 13, 2014, applicants will have to undergo a review of their income to make sure they can keep up with financial aspects of owning a home other than the mortgage payment. Such expenses are
- Property taxes
- Homeowners association dues
- Homeowners insurance and flood insurance
The lender will review income from sources such as employment, pension, and even withdrawals from IRAs and 401ks. The borrower must demonstrate they have enough residual income to pay for ongoing home ownership costs. Otherwise, the homeowner could lose their home for reasons other than the mortgage payment.
There are closing costs associated with a reverse mortgage yet because the borrowers receive cash from the transaction, any and all closing cost are deducted from the reverse mortgage loan proceeds instead of paid from the borrowers own funds. Therefore, bank and investments statements are not needed in order to verify sufficient funds to close on a reverse mortgage.
Appraisal and Property
The property is the single most important factor when it comes to a reverse mortgage. For this reason, expect heightened scrutiny on the property. The lender will require any deficiencies to be repaired prior to closing the loan. The borrower will need to pay for these repairs out-of-pocket and can’t use loan proceeds, except to reimburse the funds after closing. Costly repairs could potentially be a deal breaker. Be sure to talk to a licensed lender about the property, and get a bid for likely repairs to see if it they are feasible to complete with existing funds.
The appraisal will show the repairs needed and will show the current value of the home. Home value is very important, as it determines how much cash is available to the borrower, or if a reverse mortgage makes sense at all.
Starting January 13, 2014, all reverse mortgages will require a credit check and a satisfactory credit history. Here are the items the lender will check:
- There are no late tax payments in the past 24 months
- There is adequate homeowners insurance is in place
- There is satisfactory payment history for revolving credit, mortgage loans, and installment accounts.
Many homeowners apply for a reverse mortgage because they are in a hard spot financially. What will happen to these individuals? An approval is still possible, but it won’t be as easy as in past years when no consideration was given to credit history during the approval process. The borrower may be required to set up an escrow account to pay for taxes and insurance, or with significant compensating factors like large cash reserves, the loan still could be approved.
If the borrower has had past due payments in the past, but those issues are resolved, it will be much easier to receive an approval.
Bankruptcy and Reverse Mortgage
A waiting period is not required for a reverse mortgage, as long as it’s not a reverse mortgage to purchase a home. Borrowers wanting to buy a home must wait two years from the Chapter 7 bankruptcy discharge, or one year from the Chapter 13 payout period, assuming payments have been made on time. The borrower must receive written permission to enter into the mortgage transaction.
All typical closing costs are applicable on a reverse mortgage. Some examples are title, escrow, appraisal, credit report, as well as other various lender fees
As mentioned above, the upfront MIP is .01% of the loan amount for the HECM Saver, and 2% for the HECM Standard (including HECM for Purchase).
There is a 1.25% annual fee that is added to the loan balance each year. In addition, interest accrues through the life of the loan. Both these costs are payable when the home is sold or upon the borrower’s death.
The loan origination fee charged by the lender can vary greatly, but the maximum is $6,000. The originating lender can charge $2,500 if the home is valued at less than $125,000. For homes worth more than that amount, the lender can charge 2% of the first $200,000 of home value and 1% of the amount over $200,000. For example, for a $300,000 home, the lender could charge a $5,000 origination fee, on top of other customary closing costs.
Reverse Mortgage Interest Rates
Most of the time, interest rates on reverse mortgages are adjustable. This means if rates go up in the future, the amount of interest owed upon selling the home may be more than expected. The exception is the lump sum option with the HECM Saver, in which a fixed rate is available.
The Reverse Mortgage Process
The reverse mortgage approval process is a little different than other loans, in that the borrower must receive counseling from a HUD-approved HECM counselor prior to making loan application. A HECM counselor can be found here. The lender is not permitted to direct you to a specific counselor, but may provide you with a list for you to choose from.
The counselor will explain the reverse mortgage process, how loans are repaid and provide the borrowers the opportunity to ask questions about the program directly to a reverse mortgage loan counselor. All reverse mortgage borrowers must complete the counseling session and provide a certificate of completion to their reverse mortgage lender.
Be sure to keep the original counseling certification signed by the counselor, as the lender may need it to close the loan. You will receive this certification by mail or from the counselor directly if the session was in person.
The lender orders the appraisal and other documentation needed in order to close the loan including an updated title report, flood certification and other items. Once the loan is through underwriting and approved, the lender will set up a time and date for the loan closing.
The borrower signs the reverse mortgage closing papers and receive their funds after three business days have passed.
Questions and Answers about the Reverse Mortgage Program
I have a mortgage on my property now, how much can I get with a reverse mortgage? Loan amounts for a reverse mortgage are calculated using the borrower’s age at the time of the application and the current appraised value of the home.
If there are any existing mortgages on the property, proceeds from the reverse mortgage must first be used to pay off and remove all current liens with the remaining amount to be disbursed as a lump sum, an equity line or a combination of both.
My parents are thinking of getting a reverse loan, what happens when they pass away? The reverse mortgage lender does not own the home nor is ownership transferred in any way. All heirs to an estate are not affected and are eligible to inherit the estate regardless of any reverse mortgage on a home.
The outstanding lien for the reverse mortgage is the original amount plus accrued interest. Once the home is sold, the reverse lender is paid and the lien is released.
Can my parents be foreclosed on? There are no mortgage payments made to a reverse mortgage lender therefore a reverse mortgage lender cannot foreclose on a property due to loan delinquency. However, reverse mortgage borrowers are required to keep property taxes and insurance current as well as maintaining the home. It’s possible that the local authority who collects property taxes could seize the home due to non-payment of property taxes.
What’s the difference between an equity loan and a reverse mortgage? An equity lender or a cash out refinance lender must determine the borrower has sufficient income to make the monthly payments back to the mortgage company. If those payments aren’t made, the home can be foreclosed upon and the home lost. A reverse mortgage does not have mortgage payments and cannot be foreclosed upon due to outstanding mortgage payments.
Do condominiums qualify for a reverse mortgage? Yes, condominiums qualify as long as the project is HUD-approved. Other qualifying properties include single family homes and 2-4 unit homes (duplex to fourplex) as long as the borrower occupies one of the units.
What are the recent changes with reverse mortgages? The biggest change is the elimination of a fixed rate on the HECM Standard. Prior to April 1, 2013, borrowers had the ability to choose a fixed rate on a lump sum payout.
If the borrower however selects the HECM Saver, a fixed rate option is available. Saver loan payouts are up to 18% lower than the maximum HECM Standard amount.
For reverse mortgage originated on or after January 13, 2014, a financial assessment will be required. Credit, income, and assets will be reviewed to make sure the applicant can continue to pay property taxes, HOA dues, homeowners insurance, and other costs of owning the home.
Is a Reverse Mortgage Right for Me or my Loved One?
With some research, a meeting with a HUD approved HECM counselor, and solid numbers from your lender, you should be able to make a good decision on a reverse mortgage. For many, a reverse mortgage can ease the burden of high monthly housing expenses that put a strain on a fixed income. And, it can allow older homeowners to stay in the homes they’ve paid for and maintained over the years.
Tim Lucas (NMLS #118763), Contributor/Editor
Tim Lucas is a mortgage writer with over 11 years of experience as a loan originator, processor, and team manager. Get a live rate quote for your home purchase or refinance at MyMortgageInsider. Visit Tim on Google+, Twitter, and Facebook.