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Reverse mortgages offer unique opportunities for homeowners aged 62 and older. A reverse mortgage isn’t for everyone needing to extract equity from their home, but is an option to consider. Here, we break down the most common reverse mortgage program – the FHA HECM, shedding light on how it works, the benefits, and potential drawbacks.
What is a Reverse Mortgage?
A reverse mortgage is a loan option that provides homeowners with regular payments, a lump sum or a line of credit from the equity in their home. Reverse mortgages typically must be repaid when the borrower moves out of the house or when they pass away.
The most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM), insured by the Federal Housing Administration (FHA). There are also proprietary reverse mortgages for those with higher home values and single-purpose reverse mortgages offered by government or non-profit organizations for specific needs like home repairs.
How the HECM Works
The FHA’s HECM is the most common reverse mortgage type. The HECM differs from a traditional mortgage loan in several key ways:
Repayment Structure: Unlike a typical “forward” residential mortgage, where repayment comes from periodic payments, a reverse mortgage is repaid in one lump sum payment. Payment for the reverse mortgage is due upon the borrower’s death or when the borrower no longer occupies the property as their principal residence.
Repaying a reverse mortgage typically requires the borrower to either sell the home, refinance the mortgage, take out a new mortgage or forfeit the house with a deed in lieu of foreclosure – meaning the bank gets your home.
Non-Recourse Loan: A HECM is a non-recourse loan, The benefit of a non-recourse loan is that the borrower (or their estate) will never owe more than the loan balance or the value of the property, whichever is lower. Non-recourse also means the only asset to repay the debt is the home.
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HECM Reverse Mortgage Eligibility
To be eligible for a reverse mortgage, individuals must meet certain requirements:
- Age Requirement: Eligible borrowers must be at least 62 years old.
- Principal Residence: The property must be the borrower’s principal residence. If there are co-borrowers, such as married spouses, at least one borrower must be living in the home for the Home Equity Conversion Mortgage (HECM) loan to close. This applies even if a co-borrower is temporarily or permanently in a healthcare facility.
- Property Eligibility: Eligible properties are typically one-unit dwellings, including condominium units.
- Ownership Status: Borrowers should ideally own their homes outright or have a significant amount of equity in the property.
- Credit Record: Poor credit may not be a huge concern, but borrowers cannot have delinquent or defaulted Federal debt that cannot be satisfied at closing. However, a past payment of an insurance claim by HUD on a previously insured mortgage doesn’t automatically disqualify a borrower from obtaining a reverse mortgage if there were valid extenuating circumstances that caused the foreclosure. Lenders typically have their own rules around credit scores and reporting.
- Mandatory Counseling: Before the HECM application is processed, the borrower must receive counseling from HUD-approved housing counseling agencies. This counseling focuses on the types of home equity conversion mortgages available, their suitability for the borrower, and alternatives to a home equity conversion mortgage.
- Mortgage Insurance Premiums: Reverse mortgage borrowers must pay mortgage insurance to reduce the risk to the lender in case of default. When you finalize your home purchase, there’s an initial Mortgage Insurance Premium (MIP) of 2% of the loan amount, followed by a 0.5% annual premium.
- Origination Fees: For a HECM loan, you’ll pay an origination fee to the lender. This fee can exceed $2,500, calculated as 2% of the first $200,000 of your home’s value and 1% of any amount above that, with a cap of $6,000.
How much equity do I need in my home for a HECM?
The FHA sets no limit, but borrowers typically need at least 50% of equity reserves in their home to receive a HECM.
Should You Get a Reverse Mortgage?
Reverse mortgages are tricky. Without a detailed review of your financials, it’s hard to answer if a reverse mortgage is your best option.
One thing is for sure, if you don’t have significant equity in the home, a reverse mortgage is likely not a great option. Even being on the low side of the required equity amount may not be the best option. Less equity means smaller payments and the potential of leaving a loved one on the hook for paying off your mortgage or the bank foreclosing on the home.
Here are the pros, cons, and primary considerations when deciding whether a reverse mortgage is right for you.
Pros of Reverse Mortgages
- Income Source: They provide a steady stream of income or a line of credit, which can be a significant financial resource for retirees on a limited income.
- Flexible Payment Options: Borrowers can select from various payment plans, including equal monthly payments for as long as they live in the home, fixed-period payments, or a line of credit.
- Non-Recourse Loan: The borrower (or their estate) won’t owe more than the loan balance or the home’s value, whichever is less, ensuring no other assets are needed to repay the debt.
- No Fixed Maturity Date: These mortgages do not have a fixed maturity date or a fixed mortgage amount, offering flexibility.
- Payment Assurance: If the lender cannot pay the borrower, HUD will assume responsibility, ensuring continuous payment flow.
- Eligibility: Available to individuals 62 years or older who own homes either fully or with minimal liens.
Cons of Reverse Mortgages
- Repayment Terms: The loan is repaid in one payment after the borrower’s death or when they no longer occupy the property, which can be a significant financial burden on the borrower’s estate.
- Interest Rates: The interest may accrue at a fixed or adjustable rate, adding to the loan balance over time, which can significantly increase the total amount owed.
- Mortgage Insurance Premiums (MIP): Borrowers are charged MIPs, including a one-time initial MIP at closing and a monthly MIP, adding to the loan cost.
- Insurance Options Limitations: The lender chooses between two insurance options at loan closure, which can impact the eventual repayment terms and insurance benefits.
- Servicing Fees: Lenders can charge a servicing fee, adding to the monthly costs for the borrower.
- Recovery of Mortgage Proceeds: The loan becomes due and payable under various conditions, such as the borrower’s death or if the property is no longer the principal residence. This may necessitate the sale of the property to repay the loan.
- Risk Assessment: Reverse mortgages can be complex and come with risks. It’s important to fully understand how the loan balance grows over time and the potential impact on your home equity and estate value.
- Long-Term Impact: Consider the long-term impact on your financial health. While a reverse mortgage provides funds now, it reduces the equity you have in your home, which could limit your options if you need to move or require funds for future needs such as healthcare.
- Costs and Fees: Be aware of the high upfront costs, such as origination fees, closing costs, mortgage insurance premiums, and ongoing servicing fees. These costs can be substantial and will reduce the net benefit you receive from the loan.
- Alternatives: Explore alternatives before proceeding. Options could include downsizing to a more affordable home, refinancing your current mortgage, taking out a home equity line of credit, or even exploring government aid programs.
- Impact on Heirs: Consider the implications for your heirs. A reverse mortgage reduces the value of your estate, which could affect the inheritance you plan to leave behind.
- Stay Informed: Ensure that you fully understand the terms and conditions of the reverse mortgage, including the obligations to maintain the property and pay property taxes and homeowner’s insurance.
- Future Flexibility: Remember that your financial needs and circumstances can change. A reverse mortgage might limit your ability to adapt to future economic challenges.
- Professional Advice: Seek advice from a HUD-approved counselor and discuss your plans with trusted financial and legal advisors to understand all implications.
- Living Arrangements: If there’s a possibility you might need to move out for health reasons or otherwise, consider how that would affect the reverse mortgage. Leaving the home can trigger the need to repay the loan.
- Non-Borrowing Spouse Protection: If you have a spouse who is not a co-borrower, ensure they are protected and can continue living in the home if you pass away or move out for reasons like long-term care.
Reverse mortgages can be a valuable financial tool for some seniors, offering flexibility and financial relief. However, they’re complex and come with risks and costs. It’s essential to understand all aspects, consult professionals, and consider how it fits into your long-term financial plan to ensure you make a strong financial decision.