The phrase “reverse mortgage” used to smack of scams and shady dealings. That’s not necessarily the case any longer. A reverse mortgage can be a good option for some people. But it can also be expensive.
The Department of Housing and Urban Development (HUD) launched the Home Equity Conversion Mortgage (HECM) program in the late 80’s. The goal of the program is to help senior adults remain in their homes and pay for their living expenses using their home equity.
Here, we’ll talk about the basics of the HECM program for seniors and then talk about whether or not this program is right for you.
Table of Contents:
What is a Reverse Mortgage?
A reverse mortgage is just what it sounds like–a mortgage that works backwards.
When you take out a regular mortgage, you make payments to build up equity. When you take out a reverse mortgage, you tap equity to get cash payments in return.
Basically, you can take out your home’s equity in either a lump sum or monthly payments. Under the HUD program, you don’t have to repay the mortgage until you no longer use the home as your primary residence.
If you move out of the home, you’ll have to repay the mortgage. The idea is that you can repay it from the sale value of the home. And this works well if property prices increase. You may even be able to pay off the balance and have some cash left over.
But this isn’t always the case.
With an FHA-insured HECM, the government will foot the bill for the difference if your home sells for less than you owe on the mortgage. This is, in fact, the primary advantage of getting a reverse mortgage through the HUD program rather than an independent lender.
Either way, the mortgage will accrue interest while it is outstanding. This interest, along with the principal of the loan, gets repaid when the house is sold to pay off the mortgage.
(Curious about how the interest will work out? Check out this reverse mortgage calculator to run the numbers for your situation.)
The interesting thing about a reverse mortgage, though, is that there is no set term. As long as you continue to meet the requirements of the loan–paying other property-related expenses and living the home primarily–you can keep living in the home. But the mortgage will continue to accrue interest, as well.
What are the Advantages?
The main advantage of a reverse mortgage is that it allows you to “age in place.” You can tap your home’s equity without worrying about making HELOC payments. This can allow you to make needed repairs on your home or to upgrade to make it more accessible. Or you can simply use the lump sum or monthly payments to make your everyday expenses more manageable.
Getting a reverse mortgage through the HUD program, in particular, is advantageous. Most reverse mortgages are written so as not to pass potential debt onto heirs. In other words, if you die and the mortgage balance is more than the home is worth, your heirs won’t take on the remaining debt.
But not all reverse mortgages are as kind to the actual borrowers. With some non-FHA reverse mortgages, you may need to repay the remaining balance when you sell your home for less than the mortgage.
In other words, if you do take out a reverse mortgage, it’s a good idea to look carefully at the HECM program. If you want to shop around with private programs, get a lawyer to look over the terms with you very carefully.
What are the Disadvantages?
The main disadvantage of a reverse mortgage is the risk of losing your home–and the equity you’ve built over decades–because you unexpectedly have to move out. A reverse mortgage is great if you actually do stay in your home until you pass away. As long as you’re not worried about leaving the home to your heirs, you’re good to go. You got to tap the home’s equity in life, and the loan is a wash for you upon your death.
However, if you have to move out of the home–even if it isn’t permanent–you may need to sell it and pay off the mortgage. With the HECM program, if you live out of the home for the majority of the year or more than 12 consecutive months, you’ll have to pay off your loan. Typically this will mean selling the house.
That means if you wind up in rehabilitative care, you may also wind up without a place to live once you get out. The only way to wiggle out of selling your home is to use another funding source to pay back the balance of the mortgage or 95 percent of the home’s appraised value, whichever is less.
Another disadvantage of the HECM program is that the loans are quite expensive. This is on par with other FHA loans, which charge additional fees in exchange for taking on greater risk. The HECM program charges the following fees:
- Mortgage Insurance: This premium can be financed as part of your loan.
- Third Party Costs: These are the charges you’d expect to find as part of buying or refinancing a home, including typical closing costs. They can include things like your appraisal, title search, surveys, and more.
- Origination Fee: You’ll pay this fee to the lender who processes your HECM loan. The can charge the greater of $2,500 or 2% of the first $200,000 of your home’s value, plus 1% of the amount over $200,000. Origination fees are capped at $6,000.
- Servicing Fee: These additional fees can be charged by the month–up to $35 per month, depending on the type of loan you take out.
As you can see, these fees can add up pretty quickly. Yes, you can finance most of them. But they can quickly eat into the proceeds you’re able to get from your reverse mortgage.
When is a Reverse Mortgage the Right Option?
The FHA HECM program may be the right option if you’re relatively certain you’ll be able to spend the rest of your life in your home. Of course, there are no guarantees in life. So even if you think you can age in place, consider alternative scenarios where you can’t.
Many seniors rely on the proceeds of a home sale to finance long-term care or assisted living. If you’ve tied up your equity in a reverse mortgage, you could find yourself up the proverbial creek with no paddle.
With that said, if you’re much older, a reverse mortgage may work better for you. HUD makes reverse mortgage decisions based partially on age. The older you are, the more you can get out of a reverse mortgage. If you’re in your 70s or 80s, you can use those funds to make the home more livable without worrying as much about getting less than your money’s worth.
Generally, though, it’s a good idea to scope out other options before getting into a reverse mortgage. We outline some of the other options, including downsizing and refinancing in this article on reverse mortgages in general.
Requirements for the FHA HECM
So if you decide that you want to move forward with a government-insured reverse mortgage, what do you need? Here are the HUD’s borrower requirements:
- Be 62 years of age or older
- Own the property outright or have a considerable percentage of equity
- Occupy the property as your primary residence
- Not be delinquent on any federal debt
- Have financial resources to continue paying other property expenses, such as taxes, insurance, and HOA fees
- Participate in a consumer information session with a HUD-approved HECM counselor
Your property must be one of the following:
- A single-family home or 2-4 unit home with one unit occupied by the borrower
- A HUD-approved condominium project
- A manufactured home that meets FHA requirements
Your financial requirements include:
- Income, assets, living expenses, and credit history verified
- Timely payment of taxes, hazard, and flood insurance premiums
Taking Out an HECM
To take out an HECM, you’ll need to connect with a HUD-approved counselor. You can find one here. The counselor will walk you through the details of this reverse mortgage. And they’ll let you know your options and how much money you can get through a reverse mortgage.
The amount of money you can get depends on:
- The age of the youngest borrower or eligible non-borrowing spouse
- Current interest rate
- And lesser of appraised value or HECM FHA mortgage limit of $625,000 or the sales price
The older you are and the more equity you have in your home, the more you’ll be able to receive as part of your reverse mortgage. The lending restrictions and amounts vary from year to year. It’s best to consult with a counselor to find out how much you can receive.
Once you know how much you’ll receive, you can decide on the type of mortgage you’ll get–either an adjustable-rate mortgage or a fixed-rate mortgage. Then you can decide what type of payments to receive.
If you choose an adjustable-rate mortgage, you can choose from these payment plans:
- Tenure: You get equal monthly payments as long as one borrower continues to occupy the property as the principal residence.
- Term: You get equal monthly payments for a set period of months.
- Line of Credit: You can get unscheduled payments or installments when you need them until the line of credit is gone.
- Modified Tenure: You can take some scheduled monthly payments along with a line of credit.
- Modified Term: You get a combination of a line of credit and fixed monthly payments for a set period of months.
If you choose a fixed-rate mortgage, you’ll automatically receive the funds as a lump sum at mortgage closing.
After you’ve chosen the terms, you’ll go through a closing process that looks a lot like closing on a new home or mortgage refinance. Once you close on your reverse mortgage, you’ll get your lump sum or begin getting your disbursements. And you won’t have to pay back a dime until you no longer live in the home. (Unless, of course, circumstances prevent you from paying your property taxes or HOA fees!)
On the surface, reverse mortgages look like a great option. And for some, they can be a good last-ditch way to age in a place they’re comfortable. But these arrangements, even when government-insured, can get really expensive really quickly. So even if you’re opting for the FHA HECM version of a reverse mortgage, take time to really understand what you’re getting into before you sign on the dotted line.