1. What is a Reverse Mortgage?
A reverse mortgage is a loan product available to homeowners of at least 62 years of age. These mortgages allow the homeowner to convert part of the equity in their home into cash.
With a regular mortgage, you make monthly payments to a lender to buy your house over time, turning your cash into equity. With a reverse mortgage, a lender makes monthly payments to you, exchanging a percentage of your home equity for cash.
Originally, reverse mortgages were designed as a loan of last resort to help cash-poor seniors remain in their homes. However, according to the AARP, participation in reverse mortgage plans has now broadened as a result of widespread TV advertising and the adverse effects of the recession.
There are three main types of reverse mortgages:
- Single Purpose Reverse Mortgages: These are offered by some local government agencies and nonprofit organizations. As the name implies, the proceeds can only be used for one purpose such as home repairs or property taxes.
- Home Equity Conversion Mortgages (HECMs): These federally-insured mortgages are backed by the U.S. Department of Housing and Urban Development (HUD). These loans account for 90% of all reverse mortgages originating in the U.S.
- Proprietary Reverse Mortgages: These are private loans and are not insured by federal, state or local governments.
2. What are the Eligibility Requirements for a HECM?
Many seniors who have lived in their homes for a long time should be able to qualify for this program. Below are the eligibility requirements.
- Be 62 years of age or older
- Own the property outright or have substantial equity
- Occupy the property as your principal residence
- Not be delinquent on any federal debt
- Participate in a consumer information session given by a HUD-approved counselor
3. How Large a Loan Can I Qualify For?
Available loan amounts are based on your age, the current interest rates available, the appraised value of your home and government imposed lending limits. For an HECM loan, this amount cannot exceed $625,000.
4. What Are My Payment Options?
The HECM program offers five payment plans:
- Tenure – equal monthly payments as long as at least one borrower lives and continues to occupy the property as a principal residence.
- Term – equal monthly payments for a fixed period of months selected.
- Line of Credit – unscheduled payments or in installments, at times and in an amount of your choosing until the line of credit is exhausted.
- Modified Tenure – combination of line of credit and scheduled monthly payments for as long as you remain in the home.
- Modified Term – combination of line of credit plus monthly payments for a fixed period of months selected by the borrower.
5. What Are the Costs for HECM Loans?
Up-front costs for HECM loans may include origination fees, servicing fees and third party fees. Mortgage insurance premiums are also required.
These fees and costs can vary widely depending on the mortgage plan. A recent HECM example generated costs and fees ranging from $5,300 to more than $9,300 for a $100,000 loan.
The loan does not need to be paid back as long as the borrower is living in the home. However, it must be repaid if the borrower moves, sells, or dies.
6. Are There Any Drawbacks I Should Know About?
Reverse mortgages can be a great option in some situations, but they do have some drawbacks. As a result, many consumer advocates and financial planners still consider these to be loans of last resort. This is one reason that financial counseling is now required in order to obtain a reverse mortgage.
Below are some drawbacks to watch out for:
- Reverse mortgages can come with very high costs and fees. These are rolled into the principal on the mortgage and reduce the amount of money that you can borrow. They will also reduce the home equity that you may want to pass on to your heirs. On small loans, the up-front fees as a percentage of the loan can be extraordinarily high. Because of these fees, reverse mortgages are a bad idea if you don’t plan on staying in your home for a long time.
- Some consumers list only the elder of two spouses on the loan in order to maximize the principal available (age is part of the loan availability calculation). However, the surviving spouse could then be required to pay the entire mortgage balance, including fees, when the borrower passes away. It is therefore advisable to list both spouses on the loan, even if this means that the available principal will be lower.
- Because these products are complex and sold only to seniors, they are particularly susceptible to predatory lending practices. It is important that you obtain counseling and fully understand the terms of the loan before entering into a contract. Be leery of anyone who suggests that you invest the proceeds from a reverse mortgage.
- Even without mortgage payments, some homeowners cannot afford to make property tax and insurance payments on their properties. It is not advisable to take out a reverse mortgage if you cannot afford these payments.
While studies show that most consumers are happy with their reverse mortgages, be sure to review all of your options a financial advisor before applying for anything. There may be better alternatives to suit your particular needs.