How A Reverse Mortgage Works, And How To Make It Work For You
If you’ve heard about reverse mortgages before, it has likely been in a negative light. There are a number of different pitfalls such as high interest rates, high fees, being locked into your current residence until the loan is paid off, and limitations on being able to leave your home to your family. These pitfalls usually cause financial experts to not recommend a reverse mortgage as a source of retirement funding.
It is true that reverse mortgages present unique challenges that have to be accounted for, and they are not the right answer for everyone. However, it is possible to navigate these pitfalls and make a reverse mortgage work to your benefit instead. In this article we’ll first thoroughly explain they work and some reverse mortgage disadvantages to expect, and then show you how one can actually work for you as a means of funding.
What Is A Reverse Mortgage?
A reverse mortgage is a type of loan that is only available to homeowners who are age 62 or older. You may also see these loans listed as HECM, or “home equity conversion mortgage,” as this is the name that was used for them when they were first approved by the Housing and Community Development Act of 1987.
In addition to being at least 62 years old, borrowers can only take out one of these loans against their primary residence. Vacation homes, secondary residences and investment properties are not eligible for a reverse mortgage.
The primary appeal of the reverse mortgage is that there are no monthly mortgage payments. How is this possible? Well, there technically are payments, since interest is due on the loan each month. However, the interest can be automatically added to the loan balance with no further penalty. So technically, no monthly payment is required, although of course it is wise to keep the interest under control.
The loan gives the borrower access to their home equity immediately. Whatever equity you have built up prior to taking out the loan is the base amount of money you will have access to, based on fair market valuation of your residence, though there are some circumstances that reduce the amount that is immediately available somewhat.
The eligibility requirements for the home are determined by the Federal Housing Administration. Most homes that are designed for one to four families will qualify. Planned unit developments, manufactured homes and condominiums can also qualify if they are FHA approved.
Navigating The Pitfalls Of Reverse Mortgage Disadvantages
A reverse mortgage is best for those who either do not currently have a mortgage on their home, or who have a mortgage that is paid down enough so that the proceeds of the reverse mortgage loan can pay off the remainder of the existing mortgage.
There are some important additional terms to keep in mind before taking out a reverse mortgage:
- You are required to complete a counseling course that makes the terms and obligations of the loan clear before you receive any funds. These courses are conducted by a HUD-approved provider in the area, and HUD can provide a list of courses close to you. There is usually a $125 fee for the course, but this can be waived in some circumstances.
- As of March 2015, borrowers are also required to undergo a financial assessment. This assessment is an evaluation of your income and credit to determine whether you will be able to successfully manage the loan. There are some extenuating circumstances for financial hardship if a borrower has trouble meeting the FHA income or credit requirements, however. The basic credit requirement is that there be no derogatory debt for the period of the past 12 months.
- You will not have access to the full home equity immediately. You will have access to most of it, but there are some limitations based on the age of the borrower at origination and the expected interest rate. This is called the “principal limit factor,” and to simplify it as much as possible, higher age and a higher expected interest rate will reduce the amount of available funds. Older borrowers can actually qualify for more money than younger borrowers, but only if they have a very low interest rate.
- There are several options for disbursement of the funds once the loan has been approved. You can get an immediate lump sum payout, a monthly payment arranged either for life or for a limited number of months or a line of credit. It is also possible to “mix and match” these methods to some degree.
- Generally speaking, the borrower is not expected to pay any additional loan balance that is in excess of the home’s valuation at the time of the loan.
There are two main areas where a reverse mortgage can trip you up. The vast majority of the loan is meant to be repaid by eventually selling the house, so of course if you never sell it, interest payments just continue to accrue every month. The other issue is if the home declines in value prior to the sale, so it is important to know the local market and how the real estate experts are expecting home values to trend. If you are in a hot market like the San Francisco Bay Area and plan to eventually sell, getting a reverse mortgage quote makes a lot more sense than if you are simply riding out retirement in an economically depressed area that shows no immediate signs of revival.
So the main things you will want to consider are your future plans and how the local housing market is expected to develop. If you plan to sell at some point and you are in a stable housing market, a reverse mortgage can actually end up working out to your benefit.
Any further questions, or are you interested in a reverse mortgage quote? Contact our professional staff and we will be more than happy to help you out.