What is a Reverse Mortgage?
Reverse Mortgage is a type of home equity loan catered to old homeowners. It doesn't require monthly mortgage payment and the payment for home equity comes out usually in a monthly way. For example, a 64-year-old homeowner who has a considerable amount of home equity may borrow against the value of their house. He/She will either then get the funds through a lump sum, fixed monthly payment, or a line of credit.
Majority of reverse mortgages are home equity conversion mortgages (HECM). This is insured by the Federal Housing Administration. HECMs are allowed to people who are 62 years or older to get a part of their home equity without having to move out the property. Moreover, you can also use HECM to buy a house.
The loan balance a HECM accrue will become due and payable when the borrower dies, moves away, or permanently sells the house. According to Federal regulations, the lenders are required to make the transaction so that the loan amount won't exceed the value of the house. Also, if the loan balance does become larger compared to the house's value, the borrower or it's estate won't be held responsible for paying the difference.
Reverse mortgage loans are most commonly used for paying home renovations, medical, and daily living expenses. Most often reverse mortgages are also used to pay off the existing mortgage so they won't have to pay the monthly mortgage payments.
A reverse mortgage can also be used as a means to add money to your retirement funds. According to the National Reverse Mortgage Lenders Association, homeowners 62 and older held $6.5 trillion in home equity in the 3rd quarter of 2017.
A reverse mortgage is a means to get much-needed cash for senior citizens whose net worth is tied to the value of their house property.
How Does Reverse Mortgage Work?
In a regular mortgage, a monthly payment is given to the lender for the use of buying a house for a set period of time. For a reverse mortgage, a loan is created that the lender pays to the homeowner. A reverse mortgage works by taking a part of your home equity and turn it into a payment. More or less, its a kind of advance payment on your home equity. The payment you get is usually tax-free. There is interest when you decide to get a reverse mortgage. The interest is placed in the loan balance which means a homeowner won't have to pay anything up front. The homeowner also keeps the title of the house property.
The house is then used as collateral for the reverse mortgage. When the homeowner dies, the funds from selling the house will go to the lender in order to repay the reverse mortgage principal, interest, mortgage insurance, and fees. Any funds that exceed what the homeowner borrowed will go to the homeowner (if still alive) or the homeowner's estate. The heirs may also pay off the mortgage in order to keep the house.
Types of Reverse Mortgage
There are 3 types of reverse mortgages :
- Single-purpose reverse mortgages - are the least expensive option. It's offered by state & local government agencies and non-profit organizations. The downside is that the loan may only be used for one purpose. This purpose must be specified by the lender. Homeowners with low or moderate income are qualified to take these loans.
- Proprietary reverse mortgages - are private loans by the companies that develop the house property. The more high-valued your home is, the bigger the loan advance you get from a proprietary reverse mortgage.
- Home Equity Conversion Mortgages (HECM) - is the most popularly used among the three. It's a federally-insured reverse mortgage under the U.S Department of Housing and Urban Development (HUD). unlike single-purpose reverse mortgages, HECM loans can be used for any purposes.
HECMs and proprietary reverse mortgages are generally more expensive than traditional home loans. The upfront costs can be high and need to be considered when you want to get one. There are several factors that depends on how much you can borrow from a HECM or proprietary reverse mortgage:
- Type of selected Reverse Mortgage
- The appraised value of the house property
- Current interest rates
- Financial assessment of ability to pay property tax and homeowner's insurance
The older you are as the homeowner, the more equity you'll have in your house. The less money you owe from the house, the more money you can get from the loan.
HECM application requires you to first meet with a counselor from an independent government-approved housing counseling agency. Some proprietary reverse mortgage lenders also require counseling.
The counselor is required to explain to the homeowner the loan's costs and financial implications. The counselor will also discuss other possible alternatives to HECM like government and non-profit programs or other types of reverse mortgages. You can also discuss with the counselor things like comparing the costs of different types of reverse mortgages, payment options, fees, and other costs affecting the total cost of the loan. Counseling agencies usually a service fee of around $120.
For HECM, There is no income requirement but lenders will conduct a financial assessment for deciding to approve your loan.
What Are The Types of Payment?
There are 6 ways to receive the loan you get from reverse mortgages. They are:
- Lump Sum - get all the money in one transaction when the loan closes. This type of payment is the only one that comes with a fixed interest rate. Other types of payments have an adjustable interest rate.
- Equal Monthly Payments - the lender will give out steady payments to the borrower provided that the borrower lives in the house as a principal residence.
- Term Payments - payment is made through equal monthly payments for a set period of time according to the borrower's choosing.
- Line of Credit - money is available for the homeowner to take if needed. The homeowner will only pay interests on the amount borrowed from the credit line.
- Equal Monthly Payments plus a line of credit - the lender provides steady monthly payment provided the homeowner lives in the home as a principal residence. If the homeowner needs more money, they can access the line of credit.
- Term Payments plus a line of credit - payment is made through equal monthly payments for a set period of time according to the borrower's choosing. If the homeowner needs more money, they can access the line of credit.
What are the Laws and Rules in Reverse Mortgage?
Eligibility for a reverse mortgage is only for houses, condo, townhouse, or manufactured homes built on or after June 15, 1976. Also according to the Federal Housing Authority (FHA) rules, owners of cooperative housing aren't eligible to get reverse mortgages since they don't technically own the real estate but rather shares of a corporation. In New York, state law prohibits reverse mortgages in co-ops.
Even thou reverse mortgages don't have income or credit score requirements, there are still requirements for eligibility. These are:
- Must be at least 62 years old
- Either owns a home free and clear or at least a 50% amount of equity
- Origination fee
- Up-front insurance premium
- Ongoing mortgage insurance premium
- Loan servicing fees
Regarding heirs, lenders must allow any heirs several months to make a decision to repay the mortgage or allow the lender to sell the house to pay for the loan. If the house in some cases turns out to be underwater during the time to sell it, the lenders can't hold the homeowner or heirs accountable.
The Department of Housing and Urban Development (HUD) requires homeowners who want to apply for a reverse mortgage to complete a HUD-approved counseling session. The counseling session costs around $125 and takes at least 90 minutes. It usually covers the pros and cons of reverse mortgages.
If you're under the reverse mortgage, then you have some responsibilities to follow. You are to stay current on property taxes and homeowners insurance. You also have to keep the house in maintenance and in good condition. If you stop living in the house for 1 year or longer, you will have to repay the loan you borrowed.
Fees and Interest Rates
Since October 2017, the Department of Housing and Urban Development adjusted the insurance premiums for reverse mortgages. It was done so that lenders can have a pool of fund that they can draw if the loan balance outgrows the house's value.
All borrowers also have to pay an annual mortgage insurance premiums of 0.5% (previously 1.25%) of the amount borrowed. The adjusted premium helps borrowers save more money.
As discussed in the types of reverse mortgages, only lump-sum mortgages have a fixed interest rate. The other five types have adjustable interest rates since the options of borrowing money spans a long time and interest rates changes throughout that span. For variable-rate reverse mortgages, they are under the London Interbank Offered Rate (LIBOR).
In LIBOR, the lender adds a margin of 1-3 percentage points to the base rates. For example, if LIBOR is 2% and you the lender has a 1% margin, then your reverse mortgage interest rate will be 3%.
A reverse mortgage is a useful financial tool to get funds. But it's only exclusive to homeowners 62 and above. It's a great way to add more funds to your retirement or get funds when there is an emergency. As a would-be applicant for a reverse mortgage, you should educate yourself on this topic to avoid getting scammed or conned.