This is a really difficult topic to explain and understand, considering the strategy and the stake involves but because of its importance, I have taken time out to break it down so you can have a firm grip of this type of mortgage.
In general, reverse mortgage works opposite to traditional forward mortgage in that instead of the borrower paying the loan in installments as with forward mortgage, the lender or lending institution pays the borrower in exchange for the borrower home equity.
What is so particular about reverse mortgage is the repayment method. You are never required to repay the loan as long as you live in the home. Repayment is only due if you leave the home for a consecutive 12 months period, or when you die. Your spouse or your real estate agent may be required to sell the home to repay the loan.
What is Reverse Mortgage?
While with traditional mortgage, you pay the lender every month to buy you home over a stipulated time frame, with reverse mortgage, you receive in which the reverse mortgage lender pay you. Reverse mortgage generally takes part of your home equity and convert it into payment to you. This can be view as a form of advance payment for your home while you still live in it.
Reverse mortgage, may also be regarded as home equity conversion mortgage (HECM Loan) form of financial product for homeowners, age 62 and above who have accumulated home equity and want to use this to supplement retirement income. Simply put, this is form of financing whereby a person (age 62 and older) may choose to receive payment in either a single lump sum, as a home equity line of credit, or as a series of monthly payments (but it’s also possible to receive a combination of these three) in exchange for his home.
Borrowers on reverse mortgage are still require paying taxes (with a fixed reverse mortgage rates for lump sum payment and variable reverse mortgage ratess for monthly payment) and insurance on the property and must continue to use the property as a primary residence for the life of the loan. On the other hand, they are not required to pay monthly mortgage payments to make.
All loans must eventually be repaid and reverse mortgage isn’t different. But unlike traditional mortgage, reverse mortgage isn’t paid back in months. Rather, it’s paid back when you die, vacate the property for longer than 12 months or sell the property. It’s important to note here that, the only way the reverse mortgage lender (bank, insurance society…) can get their money back is through the sales of the property. For this reason, reverse mortgage is known as a nonrecourse loan.
To be eligible for a reverse mortgage loan, you may have to fulfil some pre-requisite conditions which include:
Age: You must be 62 years and older. Reverse mortgage intended mainly to provide income to seniors on retirement
Equity: You must have enough equity in your home to justify the reverse mortgage
HUD standard: It must be a single family home, two-to four unit property, townhouse, condominium, or manufactured home that was built after June 1976 i.e. it must meet HUD standards
Lending amount: the lending amount depends significantly on your age, your property’s value, and the reverse mortgage rates on the loan.
Residence: The property must be your primary residence
Loan repayment: If you decide to sale the property, the home isn’t the primary residence for more than 12 months, or you die the loan comes due. Thus either you or the bank has the option to repay the loan or put the home up for sale to settle it.
Good insurance standings: You must remain current on your homeowner’s insurance and property taxes for the life of the loan
Good faith: The bank approving the loan must be the first lienholder on the property. All other existing mortgage must be settled with the loan from the reverse mortgage.
Homeowners wishing to take a reverse mortgage loan may be required to receive a mandatory counseling usually by an independent third party (a national counseling agency such as AARP or an agency approved by the Department of Housing and Urban Development). The main purpose is to help homeowners review alternative options
Breakdown Reverse Mortgage
From the prospective of a traditional mortgage, as you pay your down the property mortgage over time, you gain equity. Thus property equity is the difference between what your property is worth and any debt that you have from mortgage against it.
Assuming you own a home worth $500,000 in current real estate market
At this current market, you own a mortgage loan of $100,000 having paid down $400,000
Your valuable home equity is therefore $400,000 not $500,000
This $400,000 worth equity may represent a large portion of your net worth and as you reach 62 or retirement age, you may want to tap into this equity to supplement your income.
There are many options for tapping into your property equity which may include;
- Selling the property (in this case the home)
- Taking a home equity loan
- Getting a home equity line of credit
These methods have some downsides which include:
- If you are not planning to move out, or if you don’t have another accommodation, selling your home doesn’t make sense
- These options (home equity loan and home equity line of credit) maybe difficult if not impossible to obtain
Here comes the reverse mortgage, the alternative reverse mortgage solution. A reverse mortgage lender (if you are qualify and your home equity suitable) may offer you a fixed monthly payments or home equity line of credit based on the value of your home equity. You can think of a reverse mortgage lender paying you monthly with respect to the amount of equity you have (in our example above, the reverse mortgage lender will be paying you based on the $400,000 equity).
How much can one Borrow?
The amount of reverse mortgage loan largely depends on how much your home is worth, the reverse mortgage rates that you are offered on the loan and how old you are. Your borrowing power increases with your age (that is, 85 years old will be able to borrow more than a 65 years old), higher amount equity and/or a more valuable home (reverse mortgage lenders prefer to give out money for a more valuable home because they are sure to easily sale it and recover their money or to someone with very high equity). Also, if reverse mortgage rates fall, your borrowing power may increase i.e. you will be able to borrow more at 3% reverse mortgage rates than at 5% reverse mortgage rates.
Types of Reverse Mortgage
There are three types of reverse mortgage to consider as you plan to take reverse mortgage.
Single Purpose RM: This is also considered the least expensive option and is offered by some state and local government agencies, and some non-profit organizations. These loans can only be used for one purpose (the name single) only which the reverse mortgage lender specified. For instance, the reverse mortgage lender may say that, the loan will only be used for home improvement, repairs, or homeowner insurance. Most homeowners with moderate and low income can qualify for this loan type.
Proprietary RM: These are mostly loans backed by private companies that develop them. You can qualify for this loan type if your home has a higher-value (higher appraised value) or if you have a high home equity and very small or no traditional mortgage loan.
Home Equity Conversion Mortgage (HECM LOAN): This is a federally-insured reverse mortgage and generally backed by the U. S. Department of Housing and Urban Development (HUD). These loans can be used for any purpose.
Propriety and HECH reverse mortgages may be more expensive with a high upfront cost compared to traditional home loans. Also, the amount you can actually borrow depends on several factors which include:
- The type of mortgage you choose
- Your age
- The appraised value of your home
- · Assessment of your willingness and financial ability to pay homeowners insurance and property taxes
- Current reverse mortgage rates
For a rule thumb, the older you are, the more equity you have in your home, and the less forward mortgage you owe on it, the more your borrowing power.
Advantages and Disadvantages of Reverse Mortgage
- It do not require monthly payment from the borrower
- There is no need to repay the loan as long as you are alive, living in the home, and keeping in terms of your loan
- There is flexibility with the means to receive money disbursed to you. You generally determine what withdrawal method best for you (lump sum, monthly annuity or credit line)
- Money got can pay off the existing mortgage loan
- Funds can improve monthly cash flow
- Proceeds may be used to pay off debts or settle unexpected expenses
- Loan is only due repayment only after the last surviving homeowner move out of the home or dies.
- Borrower must maintain the home and pay homeowners insurance and property taxes.
- Can complicate one’s wish to keep the home in the family
- Fees and other closing costs may be high
- If the home is sold at a lower amount to the reverse mortgage paid, the reverse mortgage lender accept his loss and cannot go after the borrower for balance
- Reverse mortgage lender may never be able to recover all funds for many reasons including devaluation.
How to Get your Money
The HECM LOAN program allows borrowers a great deal of flexibility in how they receive their money of the reverse mortgage. These means include:
- After the loan closes, withdraw a lump sum of cash
- Tenure annuity: receive a monthly annuity for as long as the borrower uses the home as his primary residence
- Term annuity: Receive a monthly annuity for a set period of time chosen by the borrower
- Take out a home equity line of credit that can be used at the borrower’s discretion. Such credit line usually grows with the passage of time.
There is the possibility to combine multiple options into plan that’s suitable for the borrower’s needs. For instance, a senior may choose to take a certain amount of cash at closing and also a home equity line of credit.
Also, there is a significant flexibility with changing from one withdrawal option to another. For instance, a borrower receiving monthly annuity may wish to switch to a home equity line of credit or get a lump sum. They can conveniently do so by paying a certain amount of fee.
Obligations of Reverse Mortgage Borrower
They reverse mortgage borrower have as obligation to:
- Continue to use the home as their primary residence
- They must continue to maintain the home, and carry out any needed repairs work
- Must stay current with their homeowner’s insurance and property taxes
Failure to keep to these obligations (in case of default), and also violation of the reverse mortgage agreement, they may be subject to foreclosure. This is the unexpected loss of one’s home which can be especially disastrous for an elderly person. Thankfully, the financial assessment act added in 2014 makes this far less likely.
How to determine if Reverse Mortgage is Right for You
The Consumer Finance Protection Bureau in 2012 put together a report to examine the reverse mortgage sector. In their report, they concluded that, seniors in the following groups were most likely to benefit from a reverse mortgage:
- People who need a home equity line but cannot qualify
- People looking to supplement a fixed income in retirement
- People looking to use a reverse mortgage as a financial tool as part of a retirement planning strategy
- People who will remain in the home for a long time
- People who purchase a home using the HECM LOAN for Purchase program
- People who want to use a credit line as a means of paying unexpected expenses, ensures a stable retirement income even if their sources of funds fluctuates and/or protect against loss of income from death of a spouse
- Those who want to pay off a forward mortgage and eliminating the monthly payment that goes along with it
If your goal is to boost your retirement income, and you aren’t worried about maintaining your equity or leaving your house to heirs, then reverse mortgage can be a great way to get some much needed cash in retirement to pay for your bills especially your medical bills.