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.