What is a Reverse Mortgage?
A reverse mortgage allows a senior homeowner to essentially borrow against the equity in their home, getting paid in a lump sum, fixed monthly payment, or line of credit.
Just like the name implies, a reverse mortgage is basically the opposite of a regular mortgage. Instead of borrowing money from a lender, you’re borrowing money against the equity you already have in your home. Anyone who is 62 years of age or older might be able to get a reverse mortgage and are often meant to benefit people who might be retired and living without a monthly paycheck. Reverse mortgages can help homeowners pay for a range of expenses, including regular living costs, home improvements, or paying for their children’s college education. There are advantages and disadvantages to a reverse mortgage, so it’s important to hear both sides of the story before making a decision.
Let’s say Jill is 65 and getting ready to retire. Since she will no longer be collecting a monthly paycheck, she plans to take out a reverse mortgage to help pay for her day-to-day living expenses. Jill’s home is worth $400,000, and she doesn’t currently have a mortgage. So she takes out a reverse mortgage for $240,000 and plans to receive monthly payments of $1,000 for the next 20 years. Once she sells the home or passes away, the loan can be repaid (along with interest, mortgage insurance, and fees) using the proceeds of the home sale.
Think of your home as a piggy bank…
With a traditional mortgage, you’re slowly putting money into the piggy bank. When you take out a reverse mortgage, your piggy bank is turned upside down and begin to take money out.
There are a number of different ways you can receive payment when you take out a reverse mortgage:
Lump sum: Get all the money once all papers have been signed to finalize the loan.
Tenure: Get equal monthly payments every month for as long as at least one borrower lives in the home, or until the money runs out.
Term: Get equal monthly payments for a predetermined period of time.
Line of credit: Get access to a line of credit, so you can borrow money when needed.
Modified tenure: Get equal monthly payments while at least one borrower is living in the home, plus a line of credit to potentially borrow more money.
Modified term: Get equal monthly payments for a predetermined period of time, plus a line of credit if you need to borrow more money.
Reverse mortgages are paid back either when the loan recipient moves out of the house or dies. At that time the money must be paid back. This is usually done using the money from the sale of the house.
A Home Equity Conversion Mortgage (HECM) is the most popular type of reverse mortgage. It’s insured by the federal government and only available through lenders approved by the Federal Housing Administration (FHA).
The FHA limits the amount of money you can borrow with this type of mortgage, with a current cap of $726,525.
This type of loan has no income limitations or medical requirements. It can also be used for any reason, which is part of what makes it popular.
A Single-Purpose Reverse Mortgage is a loan from a state, local, or nonprofit agency. You can only use it for one reason, such as to pay property taxes or repair your home, and the lender must approve of the purpose of the loan.
You might be eligible for a Proprietary Reverse Mortgage (aka “jumbo reverse mortgage”) if your home is worth more than the lending limit for an HECM (currently $726,525).
While this type of mortgage allows you to borrow more money, it is not insured by the federal government, and you’re likely to pay a higher interest rate.
As with any significant financial decision, there are both advantages and disadvantages to taking out a reverse mortgage. It’s important to weigh both sides before making a final decision.
It can be one of the only ways of getting money if you’re over 62 and struggling financially.
Payments from a reverse mortgage (especially in the case of a HECM) can be used for a variety of purposes.
You can stay in the home you have worked so hard to build equity in.
Reverse mortgages often carry high fees and interest rates. Fees are incurred for origination, servicing, recording, and other closing costs. The average rate for a fixed-rate reverse mortgage in 2019 is 4.76%, according to The U.S. Department of Housing and Urban Development (HUD).
When you take out a reverse mortgage, you reduce the equity in your home. That could mean having fewer assets to leave to your heirs and the possibility of your family having to sell your home to pay back the loan.
If you don’t pay the home insurance and property taxes, you run the risk of losing your home. Failure to pay either of these could lead to foreclosure.
Because seniors are often an easy target for scammers, there are a number of scams that specifically target reverse mortgages. We’ll cover those more thoroughly in a later section.
Since HECMs are regulated by the FHA, there are rules associated with these loans.
The first rule is that you must be at least 62 years of age or older. You must live in the home as your main residence, and you have to own most or all of it, according to HUD. Lenders may have a specific requirement on how much equity you need, but typically you should own at least half.
You also have to go through a counseling session with a counselor approved by HUD before taking out a reverse mortgage, so they can discuss the pros and cons of this type of loan.
While there are fees associated with reverse mortgages (which we’ll talk more about shortly), the federal government has put limits on them.
In addition, you must continue to pay property taxes, homeowner’s insurance, and any homeowner association fees. Failure to stay current on these could result in losing your home.
Because HECM loans are federally regulated and insured, the following fees are set by HUD:
Mortgage insurance premiums: Pay 2% of the loan balance at closing and 0.5% of whatever remains of the loan each year.
Origination fee: Pay whichever is greater — $2,500 or 2% of the first $200,000 in home value plus 1% of the home value over $200,000. There’s a cap of $6,000.
Third-party charges: Additional fees could include an appraisal, title search, insurance, inspections, among other things.
Interest: The 2019 average is 4.76%.
Servicing fees. Lenders provide a range of regular services as long as you hold the loan, such as sending you payments and statements and making sure you’re on top of insurance and real estate tax payments. The cap for this fee is $30 if the interest rate is fixed or adjusted once a year, or $35 if the rate is adjusted on a monthly basis. For Single-Purpose Reverse Mortgages, the interest rate and fees tend to be lower than for a HECM.
But with or a Proprietary Reverse Mortgage, you’ll probably pay higher interest rates to make up for the lack of mortgage insurance.
It’s possible to get out of a reverse mortgage after the closing date.
First of all, there is a three-day “right of rescission” period, when you can change your mind about taking out the reverse mortgage without penalty.
Even after the initial cancellation window is shut, you can always pay off a mortgage — along with interest, insurance and whatever other fees you have incurred.
So let’s say you take out a reverse mortgage of $240,000 to be paid out in $1,000 monthly payments. If, after one year, you decide you want to repay the reverse mortgage, you would have to pay back $12,000, plus fees and whatever interest has accrued.
When the borrower of a reverse mortgage dies, the loan must be repaid. This is typically done by selling the house. But that’s not the only option.
There might be a situation where someone takes out a reverse loan and then dies, leaving the house to their children. Rather than selling the house, the children might choose to pay back the reverse mortgage (along with any fees and interest) to keep the home.
Unfortunately, there are people out there looking for ways to scam unsuspecting seniors out of their hard-earned money and home. These scammers are often strangers but also are sometimes loved ones.
These scams can come in the form of contractors or home-improvement vendors convincing seniors to take out a reverse mortgage to pay for remodelings and repairs they don’t need.
Under another common scenario, a financial advisor may convince a homeowner to take out a reverse mortgage to pay for stocks or insurance products that may not be in their best interest.
Another type of scam involves going after seniors who are at risk of losing their homes to foreclosure. The scammer ultimately has the homeowner transfer the title to them, leaving them without a home or the funds from the reverse mortgage.
And sadly, some scams involve the children or other loved ones of a senior convincing them to take out a reverse mortgage for their own benefit.
Here are some ways to avoid becoming the victim of a reverse mortgage scam:
Seek out reverse mortgage counseling before committing.
Be wary of anyone (including a loved one or financial advisor) asking you to give them power of attorney.
Don’t sign anything you don’t understand.
Do not accept unsolicited offers.
Never agree to a reverse mortgage that requires you to transfer the title of your home.
A good way to avoid being scammed might be to use the lender list maintained by HUD.
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