Reverse Mortgage - Lifetime Mortgage, HECM Loans
What is a Reverse Mortgage and is it Right For You?
Last Updated: March 16, 2016
If you are an older American living on a fixed income, a reverse mortgage might be a good idea if you need additional retirement income, to pay for medical expenses, or to finance a much needed home improvement. In essence, a reverse mortgage allows people who are 62 years of age or older, house-rich yet cash-poor, to cash in on the equity in their homes without having to sell the home or take on a second mortgage.
How Does a Reverse Mortgage Work?
In a conventional mortgage, you make regular monthly payments to a mortgage lender for the principal and interest owed on your house. In a reverse mortgage, you actually receive money back from the lender based on the principal that is already in your house. This money does not need to be repaid for as long as you remain in your home and use it as your primary residence. Instead, the loan will be repaid upon your death or sale of your home, or if you no longer use your home as your primary residence.
Who Qualifies for a Reverse Mortgage?
In order to qualify for a reverse mortgage, you must be 62 years of age or older, own your home outright, or have a low mortgage balance that can be paid off at closing with proceeds from the reverse loan, and you must live in the home. Your home must be a single family home or a 1 to 4 unit home with one unit occupied by the borrower. HUD-approved condominiums and manufactured homes that meet FHA requirements are also eligible.
Types of Reverse Mortgages
There are two basic types of reverse mortgages: single-purpose and federally-insured reverse mortgages.
- Single purpose reverse mortgages are offered by state and local government agencies (and some non-profit organizations). The costs of obtaining a single-purpose loan are quite low; however, the loan itself is not available in all states and regions. Single-purpose loans must be used for a legitimate purpose (specified by the lender), like payment of property taxes. The loan is also, as its name states, for a single purpose only.
- Federally-insured reverse mortgages, also known as Home Equity Conversion Mortgages (HECMs), are backed by the U.S. Department of Housing and Urban Development (HUD). Proprietary reverse mortgages are private loans sponsored by individual corporations. Both of these loan types are more expensive but are also more widely available. They have no income or medical requirements and can be used for any and multiple purposes.
HECMs require that you first meet with a house counselor who is government-approved. This counselor will explain the costs and benefits of the loan as well as other alternatives (such as other government or even nonprofit programs). The total amount of money that you can borrow will be calculated based on your age, the appraised value of your home, your home's location, and current interest rates. You will also decide how the HECM is paid out to you- whether as a series of fixed cash advances, as a line of credit, or both.
The downside to obtaining an HECM is that, because it is government sponsored and regulated, oftentimes the cost of obtaining one will be the same no matter where you go. All HECM lenders must follow HUD rules, so the payout percentage, fees, and interest rates may be preset to certain values. Therefore, if you live in a higher-valued home or have a good amount of home equity, it may be better to shop around for a private company for a reverse mortgage loan.
Things to Look for When Thinking About Getting a Reverse Mortgage
- Find Out What Index the Loan Uses. Reverse mortgages have typically based their interest rates on the Constant Maturity Treasury, or CMT, index, which is based on treasury bonds. However, other loans base their interest rates on other indices, such as the London Interbank Offered Rate, or LIBOR index. Using the LIBOR index often allows for lower interest rates; however, there can be higher initial fees for securing a lower interest loan. If you are able to secure a fixed rate low interest loan, that higher initial fee may be worth it.
- What are the Fees? Earlier this year, the Federal Housing Administration began reducing their fees by about 40 percent and other banks have followed suit. Prior to this, the fees for securing a loan could be as high as 5 percent of the home's value. Fees can be paid upfront or financed into the loan and are usually dependent on the amount borrowed. If you are seeking just a lump-sum payout and have a home with high equity, some lenders are willing to reduce fees or even eliminate them altogether.
- Check Out the Types of Fees Being Charged. There are many types of fees, as well as costs, associated with obtaining a reverse mortgage loan. Lenders can charge an origination fee for obtaining the loan and there are the usual closing costs to consider. Sometimes a lender will also charge a servicing fee for the duration of the loan. Many lenders are now waiving some of their fees - make sure to ask.
- Be Aware of Pitfalls. Keep in mind that getting a reverse mortgage means that you will owe more money over time. While this may seem obvious, what some people forget is that, as the principal on a house diminishes, interest increases. This interest is added to the total amount owed and is not tax-deductible. Thus, a reverse mortgage could potentially use up all the equity in your home and even leave you with a higher debt than you started with when first purchasing your home. Fortunately, most reverse mortgages contain a non-recourse clause which prevents you or your heirs from owing more than the value of the home when the loan is finally repaid.
- Cancellation Clause. Finally, a reverse mortgage, regardless of reason, can be canceled up to three business days after the signing of the documents without penalty. You must cancel in writing, and the lender is obligated to return all the money you paid for the actual financing.
In conclusion, a reverse mortgage is a good way for senior citizens to obtain cash without losing their homes. However, it pays to be aware of the fees and interest rates associated with these loans. Be sure to consider all your options first before starting a reverse mortgage loan. The AARP Foundation and the U.S. Department of Housing and Urban Development may also be contacted for additional information.