What is A Reverse Mortgage and How Do They Work

what is a reverse mortgage and how does it workWhat is a reverse mortgage? It’s just a mortgage. There are lots of bells, whistles, features, and benefits that come with a reverse mortgage, but it’s still just a mortgage.

When I say reverse mortgage, I am referring specifically to the Home Equity Conversion Mortgage or HECM. It is a mortgage that was strategically designed for homeowners 62 and older to utilize housing wealth during retirement. This loan product is regulated by US Department of Housing and Urban Development, “HUD,” and insured by the Federal Housing Administration, “FHA.”

It is an FHA loan. Typically, when people think of an FHA loan, they think of first-time home buyers. FHA helps people at both of ends of their lives. Early on into adulthood the FHA loan can help people buy their first home with a minimal down payment. Towards the latter part of their lives FHA helps people utilize the housing wealth they have built up during their career.

The reverse mortgage is an amazing financial tool that comes with a variety of safety features for the borrowers. It can be used for a variety of situations and can be structured in many ways to meet the needs of the borrower.

How Does a Reverse Mortgage Work

Besides wanting to know what a reverse mortgage is, people want to know how they work. The HECM (Home Equity Conversion Mortgage) or reverse mortgage, is for seniors that are 62 or older. While spouses younger than 62 are not eligible as borrowers, they are considered “non-borrowing spouses.” Eligible non-borrowing spouses are given certain protections should they survive the eligible borrower. Eligible spouses under the age of 62, at the time of application, can defer the sale of the home and remain in the home if certain requirements are met.

Monthly mortgage payments are voluntary. There are no monthly mortgage loan payments required with this loan. You still have to pay property taxes, homeowners insurance and other property related expenses.
If a borrower chooses not to make a monthly payment, interest and mortgage insurance are deferred and are added to the loan balance on a monthly basis.

The loan balance grows over time because of these deferred payments and accruing interest. While there are no monthly payments required, you must continue to pay property taxes, homeowner’s insurance and other homeownership costs.

If a borrower chooses to make payments, the payment will be applied to the loan balance. And depending on how the loan is structured, the payment will also increase the line of credit. You can pay is much or as little as you want whenever you want. You can stop, skip, freeze, resume, reduce or increase payments at any time. You are still responsible for for paying property taxes, homeowners insurance and other property expenses.

Because mortgage payments are voluntary, there are no mortgage payments due until any of the following happen:

• The property is sold.
• Interest in the property is transferred.
• The last surviving borrower permanently moves out of the home for more than 12 months.
• There is no eligible surviving spouse to maintain the property as their principal residence.
• You are not meeting loan obligations such as paying property taxes, homeowners insurance, and other property charges

Technically your loan balance could exceed the home’s value at some time in the future. However, this is a non-recourse loan. This means that you can never personally owe more than the home is worth. The only recourse the lender has to get paid is the sale of the home. The sale of the home satisfies the lien regardless of what is owed on it. The lender cannot pursue the borrower, estate or heirs for any losses associated with the loan.

When the last spouse passes away the home goes to your estate. Your estate / heirs then decide what to do with the property. If they want to keep the property they will need to pay off the loan which they could do with cash or a mortgage (assuming they qualify for a mortgage). If you or your family sells the home for more than what is owed, you or your family will net any proceeds from the sale that exceed the loan balance, less any real estate agent and title/escrow fees.

The loan is active for as long as you live in the home. There are no balloon payments, pre-payment penalties or equity sharing. It is unlikely that you will out live the term of the loan as it is in affect until the youngest borrower is 150 years old.

You must continue to pay taxes, homeowner’s insurance, HOA dues (if applicable) and flood insurance (if applicable). You must maintain the property and use it as your principal residence.
You can pay off the reverse mortgage at any time either through a refinance or with cash. You can sell the home at any time as well.

As long as you are following the terms in your mortgage agreement, the bank can never take your home. This is true regardless of what home prices do, how much you owe or whether or not you still have funds available.
There is some qualifying for the program. Credit, mortgage/rent, tax and insurance payment history will be looked at. There are also disposable income requirements based on household size. Qualifying for these loans is usually easier than a traditional mortgage.

Without the government, the Home Equity Conversion Mortgage or HECM would not even exist in its present form today. Since the loan is regulated by HUD and insured through FHA, the combination created something that the free banking market never could. It created a loan with lower rates, more favorable terms, and significantly lower risks to both the lender and borrower.

To understand what I am talking about, think about the massive risks associated with a reverse mortgage to both the borrower and the lender. There is a potential that the loan balance could greatly exceed the value of the home which puts both the lender and borrower in a situation that could create a significant loss for both.
Without the government’s insurance program, lenders would have to charge significantly higher interest rates and significantly reduce the amount of money someone could borrow to make up for the loans they lost money on.

Because FHA insures these loans, the lender is protected against a loss should the loan exceed the value of the home. The borrower is protected by FHA in two different ways.

First, the loan is non-recourse which means they are not personally liable for the loan and the lender cannot pursue them or the estate for any losses. The only recourse the lender has to get paid is through the sale of the home. The sale of the home satisfies the loan regardless of what is owed.

Secondly, it guarantees the borrower access to their funds, assuming they are following the terms of the mortgage, regardless of the home’s value.

Finally, because of this insurance, borrowers reap the benefit of lower interest rates, and they can get access to more of the home’s value.

What Are the Requirements to Get a Reverse Mortgage?

  • You must be 62 years of age or older.
  • Own the property outright or have significant equity in the property.
  • Occupy the property as your primary residence.
  • Not be delinquent on any federal debt.
  • Have financial resources to continue to make timely payment of ongoing property charges such as property taxes, insurance and Homeowner Association fees, etc. Financial resources is vague as it can be almost any type of income, liquid assets, and even the equity in the home.
  • Participate in a counseling session by a HUD- approved HECM counselor.

How Much Can You Borrow with a Reverse Mortgage?

The amount you can borrow is based on several factors which include the following:

  • Age of the youngest borrower or eligible non-borrowing spouse. The older you are, the more you can borrow.
  • Current interest rate. The lower the rate, the more you can borrow.
  • Lesser of appraised value or the HECM FHA mortgage limit or the sales price. The higher the home value, up to the max claim amount or mortgage limit, the more you can borrow.

In other words, the HECM is not a one size fits all when it comes to the amount you can borrow. There are plenty of online calculators. However, in order to get the most accurate numbers your should request a quote from a lender.

How Do You Get Access to Funds Available in a Reverse Mortgage?

When it comes to adjustable interest rate mortgages, you have the flexibility to choose from the following payment plans:

  • Initial Draw: This is the initial amount of cash you draw from the loan as a lump sum.
  • Tenure: This option offers equal monthly payments for as long as at least one borrower lives in and continues to occupy the property as their primary residence.
  • Term: With this plan, you can enjoy equal monthly payments for a specific fixed period of months or years that you select.
  • Line of Credit: This plan allows you to make unscheduled payments or scheduled installments, at your discretion, until the line of credit is fully utilized.
  • Modified Tenure: This option combines a line of credit with scheduled monthly payments. You can enjoy the benefits of both as long as you remain in the home.
  • Modified Term: Similar to modified tenure, this plan combines a line of credit with monthly payments. However, the monthly payments are limited to a fixed period of months, as chosen by you.
  • For fixed rate reverse mortgages, the Single Disbursement Lump Sum payment plan will be provided, where you will receive a one-time lump sum payment.

What Are the Fees With a Reverse Mortgage?

You have the option to finance most of the costs associated with a HECM reverse mortgage and have them paid from the loan proceeds. Fees that are typically paid out of pocket are the counseling and appraisal fees. Financing the costs means you don’t have to pay for them upfront. However, it’s important to note that financing the costs will reduce the total loan amount available to you.

The HECM loan encompasses various fees and charges, which include:

Mortgage Insurance Premiums (Initial and Annual): This includes an initial Mortgage Insurance Premium (MIP) of 2% of the max claim amount, paid at closing. Throughout the loan’s duration, you will be charged an annual MIP equal to 0.5% of the outstanding mortgage balance. The MIP guarantees that you will receive the expected loan advances, and you can choose to finance it as part of your loan.

Third-Party Charges: These are closing costs incurred from third parties, such as appraisal fees, title search and insurance, surveys, inspections, recording fees, credit checks, and other related fees. Third party fees vary depending on the state and county.

Origination Fee: To compensate the lender for processing your HECM loan, you will be required to pay an origination fee. The fee can either be the greater of $2,500 or 2% of the first $200,000 of your home’s value, plus 1% of the amount exceeding $200,000. It’s important to note that HECM origination fees are capped at $6,000.

What Types of Property Qualify for a Reverse Mortgage?

Single Family Homes
Mult-Family Homes up to 4 units, such as a duplex, triplex of fourplex.
Manufactured homes that meet FHA standards. This includes, built on or after June of 1976, have HUD tags, have been detitled, only been moved once, and not in a flood zone. You must own the land. Manufactured homes in a park where you lease will not qualify.
Condo’s that are in a HUD approved condominium project or meet FHA single unit requirements.

Should you have more questions about the reverse mortgage, if you would qualify and for how much. Give us a call or schedule an appointment.