What is a Reverse Mortgage?
It’s now common for Americans over the age of 60 to struggle with the rising cost of healthcare. They have limited income, and their monthly cash flow is often inadequate to cover everyday living expenses like food, electricity and out-of-pocket medication costs. What many people around or beyond retirement age do have is equity in their homes. Equity wasn’t easily turned into cash for daily expenses until the reverse mortgage loan was created.
Equity is financial value that exists in a home after the owner has paid off the mortgage loan or has at least decreased the amount owned on the loan over a number of years. The amount of equity in a home is determined by the current market value of the property minus any debt remaining on the mortgage loan or other liens. Many people over the age of 60 own homes and have a wealth of equity, and reverse mortgages make it easy to convert that value into cash.
So, why are these loans referred to as “reverse” mortgages? It comes down to the direction of cash flow, which is opposite of a standard home loan. A standard loan requires the lender to pay out a large sum of money on behalf of the borrower, and then the borrower makes payments to the lender until the
debt is satisfied. A reverse mortgage starts with the lender giving money directly to the borrower, and then the ongoing payments flow from lender to borrower rather than the reverse.
This benefits seniors because they receive a large lump sum of money or ongoing payments that they can use as an added stream of income. They never have to worry about making a payment on the mortgage until they move out of the home, sell the home, pass away or otherwise vacate the property.
While reverse mortgages were initially developed to help seniors turn equity into cash for healthcare and living expenses, there are no restrictions on how the money is spent. Some people now use these mortgages to obtain lump sums of cash for major purchases while others simply save their payments for security against future expenses. How you use the payments received from a reverse mortgage will depend on your current health and living circumstances as well as your financial goals.
How Does a Reverse Mortgage Work?
Does the basic concept of a reverse mortgage sound too good to be true? This is often the initial response when a consumer first learns about this unique home loan, but gaining a deeper understanding of how reverse mortgages work will help you understand why these loans make complete sense for many seniors today.
The simplest way to understand the mechanics of a reverse mortgage loan is to break it out into simple steps:
The homeowner applies for a reverse mortgage quote. This gives you a reasonable estimate for how much money you may receive if you move forward with the loan process, but it isn’t a guarantee that you will qualify for a reverse mortgage or receive that amount. It’s the same as asking for a car insurance quote, so there is no obligation to proceed if you decide not to pursue a loan at this time.
An application is submitted on behalf of the property’s title holders. Ideally, every person listed on the title is at least 62 years of age. If a title holder is younger, a review will take place to determine the eligibility of the property. We’ll talk about the qualification criteria later in this FAQ sheet. Proprietary reverse mortgages are available, but most seniors apply for a Home Equity
Conversion Mortgage, which is otherwise known as HECM and is backed by the federal government.
A financial assessment is completed to ensure that the homeowner can afford to pay property taxes and other essential expenses after securing the reverse mortgage. If the lender believes that the homeowner may struggle to keep up with their financial responsibilities, they can deny the application or ask for a portion of proceeds from the loan to be set aside for direct application to those responsibilities.
HECM reverse mortgage loans require the borrower to see a counselor. This is an expense covered by the borrower and is intended to educate the homeowner so that they understand the benefits and risks of securing a reverse mortgage loan.
The property is appraised to determine the current market value. For the HECM loan, the appraiser will also determine if repairs are needed to get the home into HUD-approved condition. This is another expense that is covered by the homeowner.
The age of the title holder, current value of the property and current interest rates are used to determine how much money the borrower may receive. If you make it to this point in the process and decide that you don’t want to continue with the loan, you still have the right to back out. Being approved doesn’t mean that you’re required to accept the deal.
The paperwork is completed, and a closing date is assigned. This is the day when the homeowner signs the loan papers and officially enters into the mortgage, but there is a Right of Rescission that still gives the owner up to three days to change their mind. There are some expenses that the borrower must cover at this time, including closing costs, the FHA mortgage insurance premium and the origination fee. In many cases, these expenses are rolled into the reverse mortgage so that little to no money is due at closing.
Money is dispersed as a lump sum, as fixed monthly payments or as a line of credit. Some borrowers take a part of the money as a lump sum and then receive the rest of the loan as payments. In most cases, no more than 60 percent of the loan is released within the first 12 months.
Those steps reflect how reverse mortgages work in general, but there are circumstances that may change some of the steps slightly. For example, if you already have a mortgage loan or another lien on your property, you may need to obtain a lump sum to pay off that debt because the reverse mortgage must be your primary lien. This is one of the few situations that may allow you to receive more than 60 percent of your loan within the first 12 months.
One important thing to note is that ownership of the property always remains with the borrower. If you need a reverse mortgage loan to cover your everyday living expenses or the cost of medical care, you aren’t giving away your home. Your loved ones will have the opportunity to obtain ownership of your property once you pass away or choose to move.
How Do I Get Out of a Reverse Mortgage?
You get out of a reverse mortgage by reaching a “maturity event,” which may include one of the following scenarios:
- All borrowers on the title move out of the home.
- All borrowers on the title pass away.
- You sell the property to a new owner.
- You fail to maintain the condition of the property for more than 12 months.
Once you reach a maturity event, the loan is due immediately. You may sell the property and use the proceeds to pay off your reverse mortgage. If you pass away, ownership of your home will go to your heirs or your estate, and they will have up to six months to settle the debt.
The loan is settled when the full amount due is paid unless that amount is more than the home’s market value. In that case, settling may involve paying 95 percent of the home’s appraised value instead of the full amount borrowed. Protection against paying more than the value of the home is one reason that so many seniors opt for the government-backed HECM loan. The difference between the amount borrowed and the value of the property is absorbed by the FHA.
Can You Sell a House with a Reverse Mortgage?
You maintain full ownership of your property when you agree to a reverse mortgage and have the right to sell at any time. Just keep in mind that your mortgage is due in full when you sell the home. You need to pay off the mortgage balance in order to release the lien on the home’s title. Any equity remaining in the home is yours once your reverse mortgage loan is settled.
Who Qualifies for a Reverse Mortgage?
Applying for a reverse mortgage quote is often the first step to determining your eligibility for a reverse mortgage loan. If you want to understand the qualifying criteria before you take that step, look over this quick list:
- All homeowners listed on the home’s title are at least 62 years of age. There are some exceptions made for couples if one owner is younger.
- The home used as collateral for the loan is your primary residence.
- There are no other liens on the property, or you intend to use a lump sum payment from the reverse mortgage to pay off a prior mortgage. The reverse mortgage loan must always be the primary lien.
- You are current on property taxes, homeowner’s association or condo fees and homeowner’s insurance.
- If you believe that you meet all of those qualifications, you may want to secure a reverse mortgage quote to see how much money you may receive. There is no obligation to proceed with the loan after taking that step.
How Much Equity Do I Need for a Reverse Mortgage?
There is no minimum amount of equity required to qualify for a reverse mortgage loan, but you need enough to ensure that the payout is worth the risk of taking on a mortgage. If you still owe a significant amount of money on a prior mortgage loan, a lump sum of your reverse mortgage proceeds will go to paying off that debt. This reduces the amount of money available to you and may defeat the purpose of securing a new loan.
If you have paid off your home or only owe a small amount on your mortgage, you’re more likely to benefit from this type of loan. The current value of your home is used to determine the maximum amount that you may borrow, but the current FHA lending limit is $636,150. If your home has more equity than that, you may want to consider a proprietary reverse mortgage loan.
What Every Senior Should Know About Reverse Mortgages
Reverse mortgages are designed specifically for homeowners over the age of 62. A reverse mortgage can provide funding in the form of either a lump sum or monthly payments to the homeowner. There are requirements for the homeowner, though. The home must be their primary residence and they must meet certain qualifications such as ability to pay the taxes on the residence. No monthly payments are due and the loan must be repaid when the last homeowner on the loan has either died or the residence is sold.
There is always a substantial amount of discussion about the value and cost of a reverse mortgage.
Are reverse mortgages a good thing? For many senior citizens, it may be a source of funds that they might not be able to obtain through any other way. A reverse mortgage can allow a senior citizen to tap into the equity they have built in their home without having to make monthly mortgage payments. Qualifying for a reverse mortgage may be easier for some individuals than qualifying for a home equity loan.
There are no limitations on what a homeowner over 62 can do with the proceeds. The homeowner must be living in the home and maintaining the property. There are no constraints on how the proceeds of the loan can be used.
Are these proceeds taxable?
The loan proceeds are not taxed or taxable. If they are used for investment purposes, any profit from that investment is taxable. Interest does accrue during the life of the loan. If interest is not paid, there is no income tax deduction for the mortgage interest. Any taxes paid during the life of the loan are deductible as allowed by current IRS code.
Do reverse mortgages have reporting requirements for the federal government? Reverse mortgages do have reporting requirements under HMDA, Housing Mortgage Disclosure Act and TRID, which stands for Truth-in-Lending Act – Real Estate Settlement Procedure Integrated Disclosure. These reporting requirements are supervised by the Federal Housing Administration. They provide adequate public reporting requirements. The reverse mortgage company is responsible for proper disclosure and can answer any questions the borrower may have regarding reporting,
Is a reverse mortgage worth the time and trouble? Are they Dangerous?
That is something that has to be answered by the individual taking out the reverse mortgage. If doing so relieves a homeowner of a debt burden, or provides peace of mind, is used for travel or other expenses, then it’s worth it. If someone takes out a reverse mortgage just to take out a reverse mortgage, then it might not be. These loans are structured to follow Federal Housing Authority guidelines. If the homeowner chooses not to make monthly payments of either principal or interest, the monthly interest accrues and the amount due and owing on the loan can increase. Because of insurance and the structure of the loan, the amount due cannot exceed the value of the home.
Often a reverse mortgage can be approved and funded quicker than traditional home equity loan. The approval process is quicker, there are fewer qualification requirements that have to be met. On the other hand, if another party such as a housing authority or homeowners’ association is involved, this could lengthen the entire process.
Could a reverse mortgage be assumed by any other party?
The borrower remains the borrower for the life of the mortgage. The entire mortgage is due and owing when the last borrower dies or the property is sold. A senior citizen could, indeed receive support from someone to make the monthly payments, but that individuals or group would not benefit financially from any tax deduction allowed for the loan.
Do Reverse mortgages require monthly payments?
Reverse mortgages do not require monthly payments. The primary danger here is that interest continues to accrue each month. Interest rolls into the amount due for the reverse mortgage. So, if a payment is never made on a reverse mortgage, the balance due will continue to grow. The result is when the house is sold, not only does the amount of mortgage have to be paid, but all of this unpaid interest must also be paid. It is possible that the amount due could become substantial.
Can reverse mortgage be used to purchase a home?
Reverse mortgages are recorded as liens against the property. If the property has any other claim other against it, this could become a problem. For example, if a reverse mortgage is made against a piece of property that is designated as low-income, for example by the municipality, the reverse mortgage company and the municipality must work together to reach an agreement between themselves and the homeowner.
Some senior citizens use the proceeds of a reverse mortgage against their current residence to purchase a new home. They are free to use this new house as rental property, if they choose. If the senior citizen decides to live in the new house, the reverse mortgage will be due and owing. They can then sell the original house, using the proceeds of the sale to close out the reverse mortgage as required. They cannot use a reverse mortgage to buy a new home and turn the original home into rental property. Reverse mortgages can be used to refinance an existing residence or buy a new one. The mortgage itself cannot be refinanced, unless the lender and the borrower have an agreement in writing that that can be done.
Can a reverse mortgage be foreclosed?
Like any other mortgage, a reverse mortgage can be foreclosed. Proper payment of taxes by the homeowner is required by contract. If these payments are not made and if the homeowner does not maintain insurance on the property, the reverse mortgage company can begin foreclosure proceedings.
Reverse mortgages can be a help or a hindarence to a senior citizen. Understanding the terms and obligations of both the lender and the borrower can be complicated. For an individual interested in reverse mortgages, they should seek information regarding their specific situation from their banker or a qualified accountant or real estate attorney.