How Do Reverse Mortgages Work? Is it Right for Me?
When it comes to your home loans, there are many options out there that can help you tap into the equity you have in your home. One of these options is a reverse mortgage. A reverse mortgage is aptly named as the key difference between a reverse mortgage and a traditional mortgage is you do not pay a lender monthly. Instead, the lender will pay you based on the equity in your home.
This makes a reverse mortgage a good option for freeing up funds for medical bills, home improvements or taxes. The other thing that makes reverse mortgages more attractive is the funds available to you will grow as the equity in your home grows. However, not just anyone can qualify for this type of mortgage. Because of the structure of this loan you need to be 62 years of age, own your home outright, and use the home as your primary residence.
If you meet these criteria, the next step is determining if a reverse mortgage is right for you. Ultimately the answer lies within you, but there are a few scenarios that make a reverse mortgage a good financial choice.
Seniors who are looking to downsize and sell their home can often find themselves looking at hefty repairs. In this situation, a reverse mortgage could help them use their home to pay for the work. Also, if high medical bills or property tax increases become a burden, a reverse mortgage can offer some financial relief.
What Are the Different Types of Reverse Mortgages Available?
Once you have determined that a reverse mortgage is the right path to pursue, it is important to weigh the different types of reverse mortgages you could qualify for. There are three types of reverse mortgages:
- Single purpose reverse mortgage
- Home Equity Conversion Mortgage (HECM)
- Proprietary reverse mortgage
The most popular type of reverse mortgage is a HECM. A HECM is backed by U. S. Department of Housing and Urban Development (HUD). A major benefit of this type of the loan is HECMs are federally-insured, and they offer flexible disbursement options. You can also use this type of loan for any expense. However, the flexibility of this loan is balanced with the extra steps to obtain one. The first step to apply for a HECM, is setting up a meeting with a counselor from an independent government-approved housing counseling agency.
A second option is a single purpose reverse mortgage. This can be an appropriate loan if you have one purpose for the funds such as home improvements or medical bills. You will work with the lender to determine this purpose upfront and be bound to use the funds only for the approved purpose.
The final type of reverse mortgage is a proprietary reverse mortgage. These are available only through private lenders and to qualify you will need to have a high-value home. The benefit of a proprietary reverse mortgage is that if you meet the criteria, you may be able to get a bigger advance on your loan. Like the HECM, lenders may require you to meet with a counselor before moving forward.
As you review your options and evaluate the different types of reverse mortgages, it is important to factor in that HECMs and proprietary reverse mortgages will most likely be more expensive than a traditional loan. This applies both to monthly interest and closing costs.
Who is Eligible for Reverse Mortgages?
Reverse mortgages are designed to help older homeowners who need to access cash flow for daily expenses, taxes or home improvements.
To apply for a reverse mortgage, you need to:
- Be least 62 years old
- Own your home outright and hold the title
- Use the home as your primary residence
- Prove that you are capable of paying bills as a homeowner
How Much Can I Borrow?
How much you can borrow with a reverse mortgage is determined by your home, your age, current interest rates, and the type of reverse mortgage you apply for. It is also based on the appraisal of your home. This will allow a lender to determine the equity based on the current housing market. When it comes to your appraised value, the health of the housing market plays a large part. This is affected by where you live, how much inventory there is, and other economic factors.
Just as with any mortgage application, you will be expected to show your ability to pay both your property taxes and home insurance.
Finally, consider that the amount you can borrow with a reverse mortgage can actually grow over time. As your home value grows or you make improvements your equity can also grow.
What Influences the Amount I Can Borrow?
The first thing that determines how much you can borrow is the type of reverse mortgage you choose. If you opt for a Home Equity Conversion Mortgage (HECM), there is a limit on how much you can take out the first year. To determine this, your lender will look at on your age, the interest rate, the value of your home, and your financial assessment.
If your home has a higher appraised value and you have a small mortgage, you might qualify for more funds with a proprietary reverse mortgage. This is a good choice if your home is worth more than the limit for an HECM, and you would like a lump sum.
For any of the reverse mortgage options, a lender will look at several factors before disbursing a loan to you. These include the home value, your age, ability to repay and the market to determine how much you can borrow.
How Will I Receive Payment?
How you received payment can vary based on the loan type. With the most popular loan, a HECM, you would have several options available for disbursement.
Here is a breakdown of these options from the Federal Trade Commission:
- A single disbursement option – this is only available with a fixed rate loan, and typically offers less money than other HECM options.
- A “term” option – fixed monthly cash advances for a specific time.
- A “tenure” option – fixed monthly cash advances for as long as you live in your home.
- A line of credit – this lets you draw down the loan proceeds at any time, in amounts you choose, until you have used up the line of credit. This option limits the amount of interest imposed on your loan, because you owe interest on the credit that you are using.
- A combination of monthly payments and a line of credit.
In contrast to these options, a proprietary reverse mortgage is only available as a lump sum at closing. However, a proprietary reverse mortgage is harder to qualify for and requires higher value in your home. Whatever your choice, the interest for the loan is added as you get receive each installment or lump sum.
When Do I Have to Repay My Reverse Mortgage Loan?
There are a few ways your reverse mortgage will become due:
- If you no longer use the home as your primary residence for more than 12 months
- Death of primary loan holder
- Failure to comply with terms of your loan
- Failure to pay taxes or insurance, or make needed repairs
In the event of your death, there are a few factors to consider. Many reverse mortgage holders want to know what happens to survivors. If you have a spouse who was not on the loan, they may be able to continue living in the home. They will need to pay taxes and maintain the home. However, your spouse will not continue to receive payments.
Because repayment may fail to your heirs, it is crucial to have conversations with them about your reverse mortgage. According to a recent Kiplinger article: [Heirs] can keep the property, sell the property or turn the keys over to the lender—and their decision is usually driven by whether there’s equity left in the property. If your heirs want to pay off the loan and keep the home, there are safeguards in place that would ensure they would not have to pay more than the appraised value of the home. This “non-recourse” clause included in many reverse mortgages means that you, or your estate, can’t owe more than the value of your home when the loan becomes due and the home is sold.
Another thing to consider when you evaluate the repayment of your loan is reverse mortgages will leave less behind for your heirs as they use up the equity in your home. That means the value of your assets goes down.
What Kind of Fees Should I Expect?
While the reverse mortgage is anything but traditional, much of the process and the fees mirrors what you will remember from a traditional loan. You must apply, show proof of your income or ability to pay and then close the loan. The costs associated also mirror a traditional loan, however, you should expect that the fees, interest and closing costs on a reverse mortgage will be higher than a traditional mortgage. Your closing costs will include origination fees, upfront mortgage insurance, and appraisal fees. It is recommended to consider this as you evaluate the reverse mortgage options. Calculating your potential closing costs and interest should be part of your decision-making process.
How is My Interest Rate Calculated?
Much like a typical loan, the interest on a reverse mortgage is calculated daily and added to the loan balance monthly. How they calculate the rate is a little more complex and factors in your creditworthiness, your age, the type of reverse loan you choose, as well as the risk to the lender. The rates of a reverse mortgage are higher because the risk to the lender is higher.
If you have a variable HECM the rate is based on the index and the margin. The index adjusts regularly as market rates change. The margin is set by the lender, so you can shop around for margins. A good starting point or average is around 2.5%, but with a little digging you can find lenders above and below this. A fixed-rate reverse mortgage would determine the interest rate at the beginning and lock it in for the term of the loan.
Whether you have a fixed-rate or variable reverse mortgage, it is important to consider the long-term costs along with the origination fees. It is not uncommon for a loan with lower closing costs to come with higher interest for the life of the loan. So be sure to calculate the overall cost of the loan before you decide on a lender and loan.
Is a Reverse Mortgage a Good Idea for You?
Deciding if a reverse mortgage is right for you requires detailed research and planning. Thankfully, this type of loan program is well-supported by the banking community and the government with many upfront steps to help guide you. For example, if you apply for a HECM, you are required to attend a counseling session before you are approved. In this session, you will sit down with a HUD-approved professional and evaluate how and if a reverse mortgage could work for you. A good reverse mortgage lender will also work with you to walk you through the process and research your ability to qualify. Because this is a very personal decision, it is recommended that you take the time to review your situation with a professional.
If you are ready to learn more about reverse mortgages, we would love to sit down with you. We encourage you to begin with a free conversation.
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*Reverse mortgages are loans offered to homeowners who are 62 or older who have equity in their homes. The loan programs allow borrowers to defer payment on the loans until they pass away, sell the home, or move out. Homeowners, however, remain responsible for the payment of taxes, insurance, maintenance, and other items. Nonpayment of these items can lead to a default under the loan terms and ultimate loss of the home. FHA insured reverse mortgages have an up front and ongoing cost; ask your loan officer for details. These materials are not from, nor approved by HUD, FHA, or any governing agency.