Reverse mortgages are a mixed blessing. On the one hand seniors can get access to the equity in their home without selling or taking on additional debt. On the other hand, these financial products are difficult to understand and often come loaded with fees. So I was glad to host a guest post from the folks at Nerd Wallet on this topic.
It’s hard to live up your golden years when your bank account is a little rusty. Sometimes basic expenses such as home improvements can seem like a financial burden. So, what do you do, and what are your options?
Well, if you’re a senior over the age of 62 and your financial situation is less than sparkling, then the term “reverse mortgage” has probably entered the conversation. And you have probably wondered whether, in fact, a reverse mortgage is the right financial decision for you and your loved ones. Here’s a basic guide to what a reverse mortgage is, how to make it work best for you, and what other options are available as alternatives.
What is a Reverse Mortgage?
A reverse mortgage is a type of loan, which is available to homeowners who are 62-years-old or older. It allows potential borrowers to access a portion of their home’s equity, which can be used to supplement social security payments, medical bills, home improvements or fill any other need for more cash.
This probably sounds familiar, right? Well, unlike more traditional home equity loans or second mortgages, where a lender simply lends you more money, the cash received from a reverse mortgage comes straight from the home’s property value.
The most attractive feature of the reverse mortgage is that no repayments are due as long as you live in the house. When you leave it — normally, at death or because you choose to move — the house is usually sold. The sale proceeds go toward covering the loan, including fees and interest that have accrued over the years. Any money left over (usually very little, if any) goes to you or your heirs. If the house sells for less than what you owe you pay nothing more. In most cases, the lender’s insurer (often the federal government) takes the loss.
The Three Types of Reverse Mortgages
There are three different options of reverse mortgages, and each has different rules and qualifications for receiving the loan.
1. Single-Purpose Reverse Mortgage
One type of reverse mortgage is a single-purpose reverse mortgage. This option is a bit rare to find and qualify for. It is offered by some state and local government agencies, as well as nonprofit organizations.
A single-purpose reverse mortgage is the least expensive option of the three types of reverse mortgages; however, they are also the most restrictive, and can’t be found everywhere. As it says in the name, this type of reverse mortgage can only be used for a single purpose, which is specified by the government or nonprofit lender. They may stipulate that the loan can only be used to pay for medical bills, or home improvements. Typically these types of loans are reserved for low-to-moderate income homeowners.
2. Federally-Insured Reverse Mortgage
A federally-insured reverse mortgage, also known as a Home Equity Conversion Mortgage (HECMs),is backed by the U.S. Department of Housing and Urban Development (HUD) and is the most common type of single-purpose reverse mortgage. These loans can be a little more expensive in the upfront costs and fees. This is because the Federal Housing Administration (FHA) insures the loan, and since you’re not repaying anything right away the premium percentage is higher than standard loans.
An HECM can be used for any reason you choose, and there are no income requirements when applying. Before someone applies, they are required by law to meet with an independent, government-approved counselor to discuss the loan, and ensure they are making a well-informed decision.
There are five different payment plans for HECM loans: tenure, term, line of credit, modified tenure and modified term. A tenure plan provides a monthly payment. Term plans are monthly payments for a fixed period of selected months. A line of credit plan offers unscheduled payments that can be withdrawn at times and amounts of your choosing until the money is gone—this option affords you the most freedom, though you must be careful to keep track of your finances. A modified tenure combines the line of credit and tenure plans, and a modified term combines a line of credit with a term plan.
3. Proprietary Reverse Mortgage
The final option is a proprietary reverse mortgage. These are loans provided by private companies. Since each company may have different requirements and rules it is important to do some research and shopping around in this situation.
Before Applying for a Reverse Mortgage
A reverse mortgage can be a good option for any qualifying homeowner that finds they need some extra income. Since you are essentially taking a loan from yourself, if you are able to pay back the amount after some time, you’re giving yourself your equity back. If however, the loan becomes due, the rest of the equity from your home will pay for the reverse mortgage and you or your estate usually won’t end up owing anything else.
That being said, there are some things you should be aware of when considering a reverse mortgage. In general, lenders charge an origination fee, an insurance premium (for HECMs) and other closing costs. It’s also possible that you will incur servicing fees during the duration of the loan. Lenders set these fees—with the exception of HECMs, which are dictated by law. There is also interest that you will have to pay on a reverse mortgage to the lender. This is usually a variable interest rate, which will fluctuate with the market conditions.
FHA-backed reverse mortgages require lenders to collect insurance premiums. Borrowers will pay 2% of your home’s value OR the FHA HECM mortgage limit for your area (whichever is lower) upfront, plus a 0.5% annual premium that accrues every month, and is added to the outstanding balance.
This can get expensive, folks! On top of the premium costs, you should expect to pay for an appraisal, credit report, title insurance, legal fees and recording fees – like you would for a standard mortgage.
And in addition, according to Bankrate.com, “Origination fees can also add up quickly and reduce the overall amount of money available to you at closing. Lenders can charge up to $2,500 for homes valued at less than $125,000. Above that amount, lenders can charge 2 percent of the first $200,000 of your home’s value plus 1 percent of the amount over $200,000. HECM origination fees are capped at $6,000.”
So essentially, on a $200,000 loan, you’re paying $4,000 in origination fees alone. If you want to find numbers more specific to your area, house value, and income, this reverse mortgage calculator will provide you with a good estimate before you go to a lender.
Finally, and most important to note, although most reverse mortgages have a “nonrecourse” clause, which prevents the borrower or the estate from owing more to the lender than the value of the home, a reverse mortgage can take up all or a significant portion of the equity of your home leaving nothing for your heirs. If you desire to leave an inheritance from your estate or have the house stay in your family’s possession, the reverse mortgage will have to be paid off in full from other funds (and is, therefore, not the soundest option if that is your plan).
What Are the Risks?
- According to the AARP, one major risk is foreclosure. If you can’t pay the property taxes and homeowners insurance (default), the bank can foreclose on your home. And it happens—about 46,000 reverse mortgages are currently in default.
- If you are married, make sure you’re both on the mortgage so that the surviving partner can still live in the house in the event the other passes away. Again, AARP claims that: “Under current HUD policy, spouses who aren’t on the loan are forced to repay if they want to keep the house. If they don’t have the necessary assets, the home is sold out from under them.”
- The loan is even a higher cost if you borrow in your 60s.
- Know your rights—lenders have been known to try to charge relatives interested in keeping the house the balance of the mortgage (including fees) even if it’s more than the house is worth.
How to Reduce the Costs of a Reverse Mortgage
- HECM Saver: The recent (2010) HECM Saver loan, charges only 0.01 percent of a home’s value up front. However, the HECM Saver usually carries a higher interest rate, and you can’t borrow as much as you can with the HECM Standard. The amount you’re allowed to borrow depends on your age, the value of the home and the interest rate.
- Get the loan later in life: while 62 is the minimum age, you should wait to get a reverse mortgage as long as you can to ensure that you will have money later in life for needs like long-term care. Generally, the more valuable your home, the less you owe on it, and the older you are, preferably in your 70s or 80s, the more money you can extract from your home. You, therefore, make the reverse mortgage work better for you.
- Compare lenders and rates, and keep track of the overall trends. For example, right now interest rates are at a low, and many are choosing a fix-rate option.
What Are the Alternatives?
Let’s face it—reverse mortgages are pricey, and they interfere with your family’s inheritance. Here are some options that may provide a similar benefit for less risk
- Cash In: Now is the time to double check your finances. Do you have substantial cash value in a life insurance policy that is no longer needed? Do you have any real estate investments that could be sold or rented? If none of these apply, you can always look into low-income assistance.
- Downsize: Rather than slowly sell your home back to the bank, you could opt to sell your home and move into a more affordable space, such as a condo, or even just a smaller home. You even have the option of renting a portion of your home, which can provide you with both income and company.
- Refinance: As mentioned before, mortgage rates are pretty low right now, so if you currently have a mortgage on your home, would refinancing lower your payments? Chances are it would. Even just an extra $300 a month is still more money in your pocket. Similarly, you could take out cash through a refinancing, and provide yourself with a more flexible form of income.
- Home-Equity Loans or Lines of Credit: These loans are less expensive than reverse mortgages and could be the better option if you just need the extra money to, say, repair or improve your home. Of course, you need to have the financial ability to qualify for the loan and make money payments. Just be sure that no matter what, thoughts of health and income included, you are able to make the payments.
Bottom line, a reverse mortgage is a high cost option, and should be considered as the aces up your sleeve, so to speak. You don’t want to use them, as the risk is high, but you will if you have to later in the game.