What is a Reverse Mortgage?
A reverse mortgage is a home equity loan designed for homeowners who are 62 years of age and older. Reverse mortgages have been around in some form for several years, but the stalwart today is the Home Equity Conversion Mortgage, or HECM. This is a Federal Housing Administration program. Over the years, the reverse mortgage has been fine tuned and today is an excellent choice for older homeowners who may be “house rich” but “cash poor.” A reverse mortgage is not to be confused with a cash-out refinance, however.
A cash-out refinance is a permanent mortgage that replaces any existing mortgages with a new one. The new loan amount pays not just the outstanding home loan but typically will include the closing costs associated with the new mortgage plus an additional amount of cash proceeds delivered to the borrowers at the settlement table. The cash-out refinance is just like any other mortgage but unlike the reverse mortgage, a cash-out refinance does require the borrowers to make a mortgage payment each month. For seniors who are trying to eliminate as much debt as possible while entering their retirement years, a cash-out refinance is typically not the better choice.
A reverse mortgage provides the borrowers with additional funds but is not a refinance. If there is a mortgage on the home being considered for a reverse mortgage, the reverse proceeds will first go to pay off the existing mortgage before sending any funds to the homeowners. Eliminating any existing mortgage payments can significantly impact a homeowner’s monthly cash flow as a mortgage payment is typically the biggest monthly expense for most. A reverse mortgage eliminates that monthly debt.
A reverse mortgage does not require monthly payments but instead the payments are “reversed” and it is the lender making the payments to the borrower. As each amount is issued to the homeowners, interest will accrue on the amounts paid. The accrued interest will be settled when the home sells and the last borrower leaves the property.
How Much Can Someone Get with a Reverse Mortgage?
Reverse mortgage proceeds are based upon several factors. First, you must be at least 62 years of age but the older you are when you take out the loan, the more cash you can take out. How much you can get also depends upon the current market value of the property as determined by a new property appraisal. The higher the value, the more cash you can receive because you have more equity. When interest rates are lower, more funds can be distributed.
Reverse mortgage proceeds can be delivered in one lump sum, a monthly payment to the borrowers, a revolving line of credit or a combination of the three. You can get more proceeds with a line of credit compared to a lump sum payment which will provide the lowest of the three options. There is no maximum loan-to-value because of the multiple factors taken into consideration but because the reverse mortgage is an FHA loan, the maximum amount must adhere to local FHA loan limits.
Further, because it is an FHA program, the property must be occupied by the borrowers as their primary residence, as with any FHA loan. Credit guidelines for a reverse mortgage have tightened up over the years but not as stringent as qualifying for a traditional mortgage. Instead, there is a limited review of your payment history on your credit accounts that can go back up to 24 months to see if there are any payments made more than 30 days past the due date and any collections or charged-off accounts. FHA guidelines define major derogatory credit as any revolving credit payments made within the previous 12 months more than 90 days past the due date or more than three such payments made within the last 12 months that show as more than 60 days past the due date.
While a thorough evaluation of income and debt is not required, there is a financial assessment made to determine if the homeowner has sufficient income to pay for property taxes when due and to keep insurance on the property in addition to regular monthly living expenses. And, at the time of application, property taxes and insurance must be current.
Most any owner-occupied property can qualify for a reverse mortgage. Homes must meet FHA property standards and the structure cannot be located in a flood zone. Eligible properties include a single family home, a 2-4 unit property as long as the borrower occupies one of the units as primary residence, HUD-approved condominium projects and FHA-approved manufactured housing.
With a reverse mortgage, the homeowners do not “sell” the home to the lender and receive the proceeds. The homeowners keep title and it is not transferred. Further, because the proceeds from a reverse mortgage are not considered “earned income” there are no federal income taxes due on the disbursed funds. Conversely, interest accrued on a reverse mortgage is not tax deductible until the loan is paid off.
There are closing costs associated with a reverse mortgage and your loan officer can provide you with an estimate of the costs you can expect at the closing table. One of the bigger fees is for mortgage insurance, which is associated with all FHA loans. Mortgage insurance for a traditional FHA loan compensate the lender for the loss should the loan ever go into default. With a reverse mortgage, the mortgage insurance means the heirs will not be responsible for any shortfall when the home is sold. If the interest accrued ultimately exceeds the current appraised value of the home or the final sale of the property, the heirs are not responsible for the difference.
One final requirement for an FHA HECM is meeting with a reverse mortgage loan counselor. This counselor is a government-approved, licensed counseling firm. The meeting with the prospective borrowers will explain the costs of the loan and how the new loan will impact the borrowers overall financial picture. The counseling will also review other options to tap into a homeowner’s equity as well as repayment options.
Reverse mortgages might not be for everyone but if you are 62 years or older or know someone who is and considering a reverse mortgage, let’s have a conversation about ways you can tap into your equity as you enter into your retirement years.