Understanding Reverse Mortgages: Benefits and Uses
What is a Reverse Mortgage?
A reverse mortgage is a loan designed for homeowners aged 62 years and older who have significance equity in their homes. By borrowing against the equity, seniors can access cash to cover living expenses in their later years, particularly when other savings or income sources have been exhausted. With a reverse mortgage, homeowners can obtain the needed funds at rates similar to those of home equity loans and home equity lines of credit (HELOC’s).
Conventional mortgage: an individual borrows money to buy a home and repays the lender overtime.
Reverse mortgage: the homeowner borrows against the equity in their already-owned home, receiving a loan that they may not need to repay during their lifetime.
Most reverse mortgage loans are not repaid by the borrower. Instead, when the borrower relocates or dies, their heirs sell the property to pay off the loan, with any excess proceeds going to the borrower or their estate.
Most reverse mortgages are provided through government-insured programs that enforce strict rules and lending standards. There are also private, or proprietary, reverse mortgages issued by private non-bank lenders, but these are less regulated and have a higher risk of scams.
How do Reverse Mortgages work?
It begins with a homeowner who either has significant equity in their property (typically at least 50% of its value) or has fully paid off the mortgage.
The homeowner, seeking liquidity by tapping into their home equity, collaborates with a reverse mortgage counselor to identify a suitable lender and program.
After selecting a particular loan program, the borrower submits an application. The lender conducts a credit check and assesses the borrower's property, including its title and appraised value.
Upon approval, the lender disburses the loan, offering proceeds structured as either a lump sum, a line of credit, or periodic annuity payments (such as monthly, quarterly, or annually), based on the borrower's preferences.
Once a reverse mortgage is funded by a lender, borrowers utilize the funds according to the terms of their loan agreement.
Some loans impose restrictions on the use of funds, such as for home improvements or renovations, while others are more flexible.
These loans continue until the borrower passes away or moves out, at which point they (or their heirs) have the option to repay the loan, typically through the sale of the property. Any remaining proceeds after repayment belong to the borrower or their estate.
Qualifications for Reverse Mortgages:
The youngest homeowner on the mortgaged property must be at least 62 years old.
Borrowers can only access funds against their primary residence and must either own the property outright or have substantial equity—typically at least 50%—with at most one primary lien. This means borrowers cannot have a second lien, such as from a HELOC or a second mortgage. If the borrower hasn't fully paid off their existing mortgage, they usually need to settle it using the funds obtained from the reverse mortgage.
Government-backed reverse mortgages typically only accept certain types of properties as eligible, which can include:
Single-family homes
Condominiums or townhomes
Multi-unit properties with up to four units
Manufactured homes constructed after June 15, 1976
For government-sponsored reverse mortgages, borrowers must attend an information session with an approved counselor.
They must also stay up-to-date on property taxes, maintain homeowner's insurance, and keep their property in good condition.
Private reverse mortgages have distinct qualification criteria determined by each lender and loan program.
Reverse Mortgages Borrowing Limits
With a proprietary reverse mortgage, borrowing limits are not fixed and vary according to individual lenders' policies and restrictions.
Under government-backed reverse mortgage programs, homeowners cannot borrow up to their home's full appraised value or the FHA maximum claim amount, which is currently $765,600. Instead, borrowers can only access a portion of their property's value.
A portion of the property's value is used to cover loan costs, and lenders usually require a buffer in case property values decrease. Borrowing limits also adjust based on the borrower's age, credit, and the loan's interest rate.
Reverse Mortgage Costs
Government-backed reverse mortgages have two main costs:
Interest Rates: If you opt for a lump sum, interest rates may be fixed, starting below 3.5%, similar to conventional mortgages and lower than other home equity loan products. Otherwise, interest rates are variable, tied to the Secured Overnight Financing Rate (SOFR), with a lender-added margin.
Mortgage Insurance Premiums: Federally backed reverse mortgages include a 2% upfront mortgage insurance premium and annual premiums of 0.5%.
Mortgage insurance is designed to protect lenders in case of borrower default.
While reverse mortgages typically do not default in the same way as conventional mortgages—where borrowers miss payments—they can still default if homeowners fail to pay property taxes, insurance, or maintain their properties adequately.
In addition to mortgage insurance, lenders also charge origination fees.
According to the U.S. Department of Housing and Urban Development (HUD), lenders can charge either $2,500 or 2% of the first $200,000 of the home's value (whichever is greater), plus 1% of any amount over $200,000.
Origination fees for Home Equity Conversion Mortgages (HECMs) are capped at $6,000.
Lenders also commonly assess additional fees, such as for property appraisals, loan servicing/administration, and various closing costs like credit check fees.
These costs are typically incorporated into the overall balance of the mortgage, allowing borrowers to avoid paying them upfront out of pocket.
What are the different types of Reverse Mortgages?
Most reverse mortgages are government-insured loans, similar to other government-backed products such as USDA or FHA loans. These loans are governed by specific rules and regulations that conventional mortgages do not have, primarily due to their government-insured status. These rules cover eligibility criteria, underwriting processes, funding options, and sometimes impose restrictions on how funds can be used.
In contrast, private reverse mortgages do not adhere to the same strict eligibility requirements or lending standards as government-backed loans.
Single-Purpose Reverse Mortgage: typically the least expensive type of reverse mortgage.
These loans are provided by nonprofits and state and local governments for particular purposes, which are dictated by the lender.
Loans may be provided for things like repairs or improvements. However, loans are only available in certain areas.
Home Equity Conversion Mortgage: (HECMs) are backed by HUD and can be more costly than conventional mortgages.
Despite this, borrowers have flexibility in using the loan funds for various purposes. They can opt to receive funds in several ways, such as a lump sum, fixed monthly payments, a line of credit, or a combination of regular payments and a line of credit.
Proprietary Reverse Mortgage: Proprietary reverse mortgages are private loans that lack government backing.
Lenders establish their own eligibility criteria, rates, fees, terms, and underwriting processes for these loans.
While they can offer a quicker and more accessible funding option, they are also susceptible to exploitation by unscrupulous individuals who target seniors, potentially defrauding them of their home equity.
Who is a Reverse Mortgage right for?
Reverse mortgages are suitable for specific types of borrowers, including:
Seniors facing substantial late-life expenses.
Individuals who have used up much of their savings but have substantial equity in their primary residences.
Homeowners without heirs interested in inheriting their home.
Who Should Avoid A Reverse Mortgage?
While reverse mortgages can be beneficial in certain situations, there are compelling reasons to avoid them. A reverse mortgage may not be suitable if:
You struggle to find a trustworthy lender or a reputable loan program.
You have other savings or life insurance that can cover your expenses.
Your heirs wish to inherit your property, or family members living with you need to stay in the property after the reverse mortgage term ends.
How and when to repay Reverse Mortgage?
Most individuals who opt for reverse mortgages do not intend to fully repay them. If repayment is a consideration, it might be advisable to avoid reverse mortgages altogether.
Typically, reverse mortgages must be settled when the borrower passes away, moves out, or sells their home. At this point, the borrower (or their heirs) can either repay the loan to retain ownership of the property or sell the home to settle the loan, retaining any surplus proceeds after repayment.
You might need to repay a reverse mortgage either through cash payment or by selling the home if:
You need to move into an assisted living facility or relocate to live with family for caregiving.
Family members residing with you wish to retain ownership of the property, and you have funds available to repay the loan (such as borrowing against a life insurance policy or using the death benefit from a policy held by your heirs).
Avoiding Reverse Mortgage scams:
Government-backed reverse mortgages are typically considered safe, but many advertisements target consumers for reverse mortgages from private companies. When dealing with a private lender or a company claiming to facilitate government loans, it's crucial for borrowers to exercise caution.
Here are some important points to keep in mind:
Avoid responding to unsolicited mailers or advertisements.
Do not sign any documents unless you fully understand them; consider consulting with an attorney for clarification.
Refrain from accepting payment for a home you do not own.
Be cautious of promises of receiving something for nothing, such as no down payment offers.
In numerous instances, these scams manipulate homeowners into obtaining reverse mortgages and handing over the funds to the scammer. Alternatively, some scams coerce homeowners into acquiring reverse mortgages with exorbitant interest rates or undisclosed terms that may lead to the loss of their property.
Here are some common reverse mortgage scams to look out for, according to the Office of Inspector General for HUD:
Foreclosure scams: These scams promise foreclosure relief through a reverse mortgage.
Equity theft scams: Multiple parties, such as appraisers and attorneys, convince homeowners to take out a reverse mortgage and then steal the loan proceeds after closing.
House flipping scams: Scammers persuade homeowners to use reverse mortgage proceeds to buy a fixer-upper, make minimal renovations, and sell it for profit. However, the property is often in poor condition, and the scammer profits while leaving the homeowner with a bad investment.
Fraud by financial planners or loved ones: Trusted individuals, like relatives or financial planners, convince homeowners to take out a reverse mortgage and manage the funds on their behalf. They then misuse the funds for personal gain.
These scams exploit homeowners' trust and financial vulnerability, making it crucial for individuals considering a reverse mortgage to be vigilant and seek advice from reputable sources before proceeding.
Reverse Mortgage Alternatives
Reverse mortgages are not suitable for everyone, and many potential borrowers may not qualify, such as those under the age of 62 or those lacking significant equity in their homes.
If a reverse mortgage is not the right option for you, there are alternative routes to secure the funding you need. These alternatives include:
Conventional mortgage
Home equity loan
Home equity line of credit (HELOC)
Selling or leasing the property
Borrowing against a life insurance policy
Tapping into savings, such as retirement accounts
Each of these alternatives offers different advantages and considerations, so it's essential to explore all options and choose the one that best fits your financial situation and goals.
Pros and Cons of Reverse Mortgages
PROS:
Provides cash for important medical expenses in later life
All costs can be rolled into the loan balance
Competitive interest rates comparable to other mortgage types
No need to repay the loan out of pocket
CONS:
Total loan costs, including fees, can be substantial
The loan must be repaid for heirs to inherit your property
Ownership of the property outright or at least 50% equity is necessary to qualify
Caution is necessary to avoid scams
Most loans require mortgage insurance
