Aging homeowners, looking ahead to retirement, and planning for how their retirement is going to be funded, have an option available which they can consider; the reverse mortgage. A reverse mortgage is a lending instrument that can be used to create a monthly income for senior homeowners.
It can also be used to access a lump-sum amount of cash for any purpose. The most common type of reverse mortgage is the ‘home equity conversion mortgage’ (HECM). HECM loans are insured by the Federal Housing Administration (FHA).
In order to even consider a reverse mortgage, a homeowner needs to meet certain basic criteria:
- A. Equity: The homeowner needs to have a reasonable amount of equity built up in his/her home. The property can have outstanding loans, but the combined balance of any outstanding loans must be low enough so that when those balances are subtracted from the property’s market value, there is still enough equity remaining in order to fund the mortgage.
- B. Age: If the property is owned by a single individual, s/he must be 62 years of age or older in order to initiate a reverse mortgage. If the property is owned by multiple individuals, at least one of those individuals needs to be 62 years of age.
- C. Residence: The subject property must be the owner(s) primary residence.
- D. Property: The property must be a single-family house, or a two, three, or four-plex structure, where the homeowner owns one unit. Certain condominiums and mobile homes on permanent foundations can also qualify.
10 most commonly asked questions about Reverse Mortgages:
Table of Contents:
- 1. Reverse Mortgages: What are The Basics?
- 2. How Long Have Reverse Mortgages Been Around?
- 3. Is My 4-Bedroom, 2-Story, Colonial Revival My New Piggy Bank?
- 4. Reverse Mortgages – What are the Nuts and Bolts?
- 5. What Are the Financial Considerations?
- 6. How Do I Evaluate Reverse Mortgages?
- 7. What’s the Best HECM Loan Checklist?
- 8. Do I Have the Right to Cancel?
- 9. Is There a Refinance Option?
- 10. What are the Reverse Mortgage Pros and Cons?
1. Reverse Mortgages: What are The Basics?
The market for reverse mortgages represents about 1% of the overall residential mortgage market. However, with aging baby boomers; those born between 1946 and 1964, the market for these instruments is expected to increase sharply in the decade ahead. This influx of more seniors over the age of 62 is only one reason why the market for reverse mortgages is anticipated to grow. The main reason is loss of income.
Throughout the twentieth century, many medium and large-sized employers offered pensions to their retiring workers. In fact, at one time, as many as 88% of private sector workers, who had some kind of workplace retirement plan, had a pension. That percentage has now decreased to 33%.
One reason for this decline is the advent of 401(k) retirement plans. However, what has driven this decline more than anything is a series of laws passed during the 1980’s and 1990’s, including The Tax Equity and Fiscal Responsibility Act (1982), The Retirement Equity Act (1984), The Tax Reform Act and Single Employer Pension Plan (1986), and The Pension Protection Act of 2006.
These laws, collectively, have had the inadvertent effect of nearly eliminating private sector pensions. While public sector employers still offer pensions to many workers, pension plans in the private sector are nearly a thing of the past.
The cumulative effect of the loss of worker pensions has resulted in retirees being financially unprepared for retirement. According to the Employee Benefit Research Institute, nearly half of retiring baby boomers won’t have sufficient assets and income to cover basic day-to-day living expenses, including health care costs. Women, in particular, are at risk for not having sufficient income and savings.
So, when Henry Winkler, or Alex Trebek, or Robert Wagner suddenly appears on the television screen pitching reverse mortgages, naturally, a retiring baby boomer’s interest is going to be piqued.
However, there is a big problem right off the bat. These mortgages are highly complex, even for a loan professional. A single thirty or sixty-second TV commercial is grossly inadequate to present all of the features and potential pitfalls that come along with these instruments. Just understanding the actual costs associated with them is a formidable challenge for anyone.
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2. How Long Have Reverse Mortgages Been Around?
Reverse mortgages are nothing new. The reverse mortgage was actually invented in 1961 at a Portland, Maine savings and loan, in order to help a recently-widowed local woman remain in her home.
In 1969, the U.S. Senate Committee on Aging investigated the idea as an actuarial mortgage plan in the form of a housing annuity, for the purpose of allowing seniors to remain in their homes after retirement. Increasing interest in reverse mortgages caused these unregulated instruments to be written by other lenders around the country.
Throughout the 1980’s, congress passed a series of laws, attempting to standardize the terms of reverse mortgages, and to build in consumer safeguards.
In 1984, reverse mortgages were, for the first time, structured so that senior homeowners could now stay in their homes as long as they wanted; until they vacated the home or until they died. Then, in 1988, HUD established FHA insurance for reverse mortgages through The Reverse Mortgage Bill, signed by President Reagan.
During the 1990’s, congress continued to amend the 1988 law with additional features and consumer protections. In 1998, The HUD Appropriations Act officially established the HECM (home equity conversion mortgage) with additional safeguards, including full financial disclosures, and mandated, third-party loan counseling for seniors interested in pursuing a reverse mortgage.
In the early 2000’s, HUD continued to tweak HECM’s, especially with financial amendments, like provisions for refinancing. The past ten years have seen a steady stream of additional revisions and adaptations. One of the challenges for loan professionals and consumers alike, is just keeping up with all of the changes, which seem to take place regularly.
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3. Is My 4-Bedroom, 2-Story, Colonial Revival My New Piggy Bank?
For most people, their home is their number one investment. Even if they have some savings, and a retirement account, they most likely have the majority of their net worth tied up in their homes. Aging and retirement often bring on some new and unexpected financial needs. There are health care-related costs and unexpected home repairs, for example.
This is also a time when a person’s income often gets either reduced or eliminated altogether. Then, of course, there are day-in and day-out financial costs just to survive, like food, clothing, utilities, taxes, and monthly bills. Older homeowners often feel the squeeze between the loss of income and increasing living costs.
If an older homeowner’s assets are primarily tied up in his home, and s/he needs additional income just to survive, his/her home’s equity may be the only source of available capital. If so, there are several ways to tap that big piggy bank of home equity.
One obvious solution is to downsize: sell the home, and find a smaller, cheaper property. If there is a reasonable amount of equity in the property, and the home is sold, there should be a big payday at closing.
However, some of that money has to be reinvested in a new residence, so that will require a big chunk of those proceeds. You’ve got to initiate a new loan on the new property, which will require a down payment, and of course, a new monthly mortgage payment. The homeowner has to evaluate how much s/he really stands to gain, just by downsizing residences.
Selling the home and moving can also be difficult or nearly impossible. A homeowner, especially an older homeowner, may not want to move. Moving is an exhausting experience for anyone. After a homeowner has been in their home for 20, 30, or 40 years, it will be emotionally grueling to move into an unfamiliar neighborhood, amongst people they don’t know.
There can actually be many reasons why an older homeowner doesn’t want to move. Perhaps they have family in the neighborhood. Maybe there are essential services close by. It doesn’t matter what the reason is. If a homeowner is strapped for cash, and feels like s/he needs to stay where s/he is and remain in his/her current home, then that homeowner may want to consider a reverse mortgage.
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4. Reverse Mortgages – What are the Nuts and Bolts?
With a standard mortgage, you make a payment each month to the lender to buy your home over a specified time period. In a reverse mortgage, the lender pays you. The reverse mortgage takes a portion of your home’s equity and converts it into regular tax-free cash advances. As long as you remain in your home, you don’t have to pay back any of these cash advances.
After you either die, sell your home, or move out, you, your spouse, or your estate will settle the reverse mortgage. Oftentimes, this will require selling the home in order to raise the funds needed to settle the loan.
There are three general categories of reverse mortgages:
- Single Purpose Reverse Mortgages: These are offered by some public sector agencies and non-profits and are generally used for a specific purpose, such as paying off medical bills or home improvements.
- Proprietary Reverse Mortgages: These are loans usually initiated by private parties and often have higher loan ceilings than federally insured loans.
- Home Equity Conversion Mortgages (HECM’s): These are federally insured reverse mortgages.
All of these instruments work essentially the same way. You get a loan where you borrow against your home’s equity, while retaining title to your home. The money you receive is tax-free and does not affect other benefits you may be receiving, such as Social Security or Medicare. When the last surviving borrower dies, sells the home, or moves out, the loan must be settled.
Sometimes only one spouse appears on the loan documents. Under the right circumstances, if a non-borrowing spouse survives the borrowing spouse, the non-borrowing spouse is able to remain in the home pending death, sale, or relocation.
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5. What Are the Financial Considerations?
There are fees and costs associated with initiating and maintaining a reverse mortgage. These include loan origination fees, loan closing costs, and ongoing fees to service the loan. Most of the time there will also be mortgage insurance premiums. If a homeowner only plans to remain in the home for a short time, or if s/he only wants to borrow a small amount, then these high loan-related costs need to be weighed against the loan’s potential benefits.
The amount charged against your equity grows over time since interest is added to your accumulated balance each month. This means you’re paying interest on interest. Interest payments on a reverse mortgage are not deductible on federal income tax returns until the loan is settled.
If your loan is written with a variable rate of interest, based on market rate benchmarks, your interest will change over time, and could easily increase. Some HECM’s offer fixed rates, but your interest rate and borrowing parameters will probably be adversely impacted, compared to a variable rate loan.
Since you keep title to your home with a reverse mortgage, you are still responsible for all financial obligations associated with maintaining your property, including taxes, insurance, utilities, and physical maintenance. If the borrower is unable to meet these obligations, the lender may require him/her to repay the loan, which will probably necessitate selling the house.
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If both spouses are signatories to the loan documents, then both have a right to remain in the home until death and receive payments, according to the terms of the loan. However, if the surviving spouse is not a signatory, s/he can remain in the home, in most cases, but is not eligible to receive any cash proceeds from the loan.
Reverse mortgages can deplete your home’s equity, leaving little of value to your heirs. Reverse mortgages typically have a ‘non-recourse’ clause, which means that when it comes time to settle the loan, the borrower, or the borrower’s estate, can’t owe more than the home’s appraised value.
The amount you can borrow against your home’s equity is determined by several factors.
- a) Your age
- b) Your home’s appraised value
- c) The type of reverse mortgage you obtain
- d) Current mortgage interest rates
- e) A financial assessment conducted by the lender to determine the borrower’s willingness and ability to pay property taxes and insurance
Generally speaking, you get the most money when;
- a. You’re older
- b. You have a large amount of equity built up
- c. You have few, if any, loans on the property
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Before applying for a HECM, a borrower is required by law to meet with an independent, HUD-approved loan counselor. The counselor must explain all of the costs and financial implications associated with the loan and is trained to make an assessment of the borrower’s ability to comprehend these implications.
HECM’s offer several payment (income) options, including;
- a) Single Disbursement: The borrower receives one lump sum once the loan is closed. The lump sum option is only available on fixed rate loans.
- b) Term: The borrower receives regular, fixed monthly advances for a specified period of time.
- c) Tenure: The borrower receives regular, fixed monthly advances for life, as long as s/he remains living in the home.
- d) Line of Credit: This allows the borrower to tap his/her equity at any time, in any amount, until the home’s equity is depleted.
- e) Combination: Some combination of regular payments and lump sum amounts.
HECM’s allow the borrower to live outside the home, in a nursing home or medical facility, for up to twelve consecutive months, as long as the home’s financial and maintenance needs are met. After twelve months, however, they loan must be called in and settled.
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6. How Do I Evaluate Reverse Mortgages?
For any homeowner considering a reverse mortgage, it is important to educate yourself as thoroughly as possible and then do a little shopping around. First, decide what you want the money for. Then, compare options, fees, and terms from different lenders. These costs vary from lender to lender. Be sure to ask lots of questions. If you live in a home with a higher market value, you may want to consider a proprietary loan, as opposed to a HECM loan.
Make sure to ask your lender to explain the loan’s Total Annual Loan Cost rate. This will give you a projected annual cost of the loan. You should also understand completely all of the reasons why the loan might have to be repaid and settled, other than the death of the borrower.
Seniors who are investigating reverse mortgages must also be wary of the salesperson who is offering the loan. Salespeople are never going to be the most accurate, objective source of information. If you feel pressured to initiate the loan, that’s a red flag.
Another red flag is a case where the salesperson offers his own ideas about how you should spend the proceeds of your loan. Maybe he’s got a brother-in-law who can remodel the kitchen or bathroom. He may also have some ideas about investment opportunities, like an annuity or long-term care insurance; or perhaps ten acres of swampland. Be careful. It’s illegal to make a reverse mortgage contingent upon the purchase of any product or service.
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7. What’s the Best HECM Loan Checklist?
Here’s a short list of factors to consider when evaluating whether or not to get a reverse mortgage.
- Why do you need the money and how will the loan proceeds be used?
- Do you completely understand a borrower’s obligations under a reverse mortgage?
- If you’re married, will your spouse be a co-borrower?
- How will you repay your reverse mortgage loan?
- Are you currently receiving any assistance under a government program which is contingent on your current income (Medicaid)?
- How long do you and your spouse want to remain in the home?
- Have you explored alternative ways to supplement your retirement income? Maybe downsizing isn’t such a bad idea, after all.
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8. Do I Have the Right to Cancel?
If you’re not sure about a particular company or salesperson, walk away. Find a loan counselor or lender you do feel comfortable with. In the case of HECM’s, and most other types of reverse mortgages, the borrower has three business days after closing to cancel the agreement. Cancellation can be done for any reason, without any penalty. This is called the borrower’s right of recission.
To cancel the loan, you must notify the lender in writing by certified mail. Make sure you keep copies of all correspondence with enclosed letters and documents. Upon cancellation, the lender has 20 days to return any and all monies paid in by you, up to that point.
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9. Is There a Refinance Option?
Homeowners who enter into a reverse mortgage can opt to refinance the mortgage, if they so choose. They may decide that they no longer need the extra income and want to leave as much of the home’s value to their heirs as possible. In this case, they would refinance to a conventional loan with monthly payments.
A homeowner with a reverse mortgage may also want to refinance to another reverse mortgage. There could be a number of reasons for doing this, but usually it’s done when the property’s value increases sharply, and the homeowner now is eligible for a larger payout. The homeowner must always take into consideration the costs associated with refinancing, and determine whether or not refinancing really makes sense in the long run.
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10. What are the Reverse Mortgage Pros and Cons?
- a) A HECM can help older people remain in their homes during retirement.
- b) A HECM can provide much-needed living expenses for seniors on fixed incomes.
- c) Borrowers can take funds in lump sums, as regular income payments, or as a line of credit as needed.
- d) Once the HECM loan is closed, and all outstanding loans on the property are settled, the borrower has no more monthly mortgage payments.
- e) Most of the costs associated with initiating the loan can be financed with the loan proceeds, so out-of-pocket expenses can be minimal.
- f) Loan proceeds are not considered taxable income, and will not affect Social Security and Medicare benefits.
- g) Once the loan is settled, any remaining equity in the property belongs to the borrower or his/her heirs.
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And the Cons
- a) The loan balance increases during the period of the mortgage as interest and loan maintenance fees accumulate.
- b) As equity is used up, there is less value to leave to your heirs. You can still will the property to your heirs, but they will have to repay the loan balance, which usually means selling the house.
- c) Fees, including interest rates, are normally higher than with a typical mortgage.
- d) Eligibility for certain federal needs-based programs may be impacted.
- e) Once a ‘maturity event’ occurs, the loan becomes due. A maturity event happens when;
- f) The last surviving borrower dies, or a qualifying non-borrowing spouse dies
- g) The home is no longer the borrower’s principal residence
- h) The borrower vacates the property for more than twelve months for medical reasons
- i) The borrower vacates the property for more than six months for non-medical reasons
- j) Failure to meet loan obligations, such as paying property taxes, insurance, HOA fees, and property maintenance
- k) Over time, inflation will eat away at the value of your monthly payments, and you will need more and more money.
- l) If some large, unforeseen expenditure related to your home arises, where will the money come from to cover those costs? Does the borrower have a secondary source of funds for these costs, or will the borrower have to sell the home to pay for them?
- m) Loan amounts are limited to about one half of your equity, and up to a ceiling of $625,000.
- n) With co-borrowers, loan proceeds are based on the younger spouse’s age, which means a smaller payout or a smaller monthly check.
- o) Following the death of the last surviving borrower, the heir or estate administrator has 30 days to declare whether the loan will be repaid or whether the home will be sold. If there is no reply after thirty days, the lender can initiate foreclosure proceedings.
If you still have questions about reverse mortgages, try contacting the resources below for reliable information. We hope you find this article helpful, please share it on your Facebook page so other seniors can benefit from it as well. Thanks in advance!
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U. S. Department of Housing and Urban Development (HUD)
Consumer Financial Protection Bureau
Considering a Reverse Mortgage?
1-855- 411-CFPB (1-855-411-2372)
Reverse Mortgage Education Project