For many families and individuals approaching retirement, their most significant asset is equity in their houses. A reverse mortgage enables a retiree to reside in the home while receiving payments based on the home equity. It is for homeowners who have built up home equity but lack retirement money. For senior homeowners, a reverse mortgage can be a useful financial tool. Learn more about reverse mortgage.
What is a Reverse Mortgage ?
A reverse mortgage is a type of loan offered to homeowners ages 62 and older that enables them to convert a portion of the primary residence’s equity into cash. With a reverse mortgage, you are able to get payments depending on the equity in your property. You must reside in the home and be 62 years of age or older. You must pay back the loan when you vacate the property, sell it, pass away, or when the term expires.
Reverse mortgage loans accrue compound interest and require timely payment of property taxes and homeowner's insurance, but they are not repaid until the borrower passes away or vacates the property. In contrast to a conventional mortgage, a reverse mortgage's balance grows over time owing to fees and interest while equity declines.
Key Facts of Reverse Mortgages
- Homeowners can use reverse mortgage loans to turn their home equity into cash income without having to make monthly mortgage payments.
- You must be 62 years of age or older and the resident homeowner.
- There are no monthly payments necessary for a reverse mortgage.
- Fees and interest are charged on reverse mortgages, and the principal debt rises over time.
- The distribution choices available with a reverse mortgage are often flexible and range from a lump sum to monthly payments.
- The loan becomes due and must be fully returned when you pass away, vacate the property, or sell it. That implies that upon your passing, your heirs might be required to assume that duty.
- Tax deductions for interest paid on a reverse mortgage are not available until the loan is repaid in full or in part.
How Does a Reverse Mortgage Work ?
A reverse mortgage is a loan that uses the equity in your home to give you dependable, tax-free cash payments. A homeowner who is 62 years of age or older and has a sizable amount of equity in their property may borrow against it and receive cash as a lump sum, a set monthly payment, or a line of credit. While a typical mortgage balance decreases as you pay it off, a reverse mortgage balance increases as you receive payments. Monthly interest is added to your balance by reverse mortgage lenders.
As long as you keep the house and adhere to the loan's conditions, a reverse mortgage's repayment might be postponed. The reverse mortgage will become due and require full repayment if you pass away, leave your home, or sell it. The money from a reverse mortgage is often obtained over a period of time, like 10 years, as a monthly payment.
With a reverse mortgage, the lender pays the homeowner instead of the homeowner making payments to the lender. The method of payment is at the homeowner's discretion, and only interest is due on the money actually received. The homeowner pays nothing up front because the interest is rolled into the loan balance. The homeowner's debt grows during the course of the loan, while home equity declines.
Note :
Proceeds from reverse mortgages are not taxable. The Internal Revenue Service (IRS) views the funds as a loan advance, despite the fact that the homeowner may perceive them as income.
Example of a Reverse Mortgage
For example, consider that the market value of your house is $400,000. You finish paying off your mortgage at the age of 63, but your savings and retirement income fall short of your needs. You might apply for a $120,000 reverse mortgage, where the lender will pay you $1,000 every month for ten years. The loan would have to be fully repaid if you sold your house and moved at the age of 70 (along with fees and interest). You may repay it using the cash from the sale of your house.
Types of Reverse Mortgages
There are various types of reverse mortgages available on the market, and you normally have a few alternatives for distribution, from a lump sum payment to monthly payments.
The most popular and affordable type of reverse mortgage is a home equity conversion mortgage (HECM). Reverse mortgages for tax credits, tax deferral, or property repairs and improvements may be available through state and local programs. Private reverse mortgage loans known as proprietary reverse mortgages are relatively uncommon because both consumers and lenders prefer the HECM program.
This sort of mortgage, a reverse mortgage insured by the Federal Housing Administration (FHA), is only offered by lenders who have been approved by the agency. Consider a jumbo reverse mortgage, also known as a proprietary reverse mortgage, if your house is worth more. You have a choice of six different ways to get the money from a reverse mortgage :
1) Lump sum :
When your loan settles, receive the entire amount at once. The only choice with a set interest rate is this one. The interest rates on the other five are adjustable.
2) Term payments :
For a predetermined amount of time such as 10 years, the lender offers the borrower equal monthly instalments.
3) Equal monthly payments (annuity) :
The lender will consistently make payments to the borrower so long as at least one borrower resides in the property as their primary residence. The tenure plan is another name for this.
4) Equal monthly payments plus a line of credit :
As long as the property is occupied as the principal residence by at least one borrower, the lender will make consistent monthly payments. The credit line is available to the borrower at any time if they require additional funds.
5) Line of credit :
The homeowner has the option to borrow money as needed. Only the money actually borrowed from the credit line is subject to interest payments by the homeowner.
6) Term payments plus a line of credit :
For a predetermined amount of time such as 10 years, the lender offers the borrower equal monthly instalments. The borrower has access to the line of credit if they require more funds during or after that period.
Who Qualifies for a Reverse Mortgage ?
You must fulfil certain standards to be eligible for a reverse mortgage. As with a standard mortgage, there are requirements you must meet after you've obtained the mortgage. The amount of money you can borrow in addition to meeting those requirements will depend on a variety of factors, such as :
- Your age (you must be over 62 or older)
- A reverse mortgage's type
- Current interest rate
- Your credit history as well as your financial status
- How much debt you may have on the house, if any
You'll need to fulfil ongoing requirements after you've been approved for a reverse mortgage and have received your money.
Requirements for Reverse Mortgage
1) Type of Property :
You might be qualified for a reverse mortgage if you are the owner of a house, condo, townhouse, or mobile home that was built on or after June 15, 1976. Due to the fact that they actually own shares of a corporation rather than the actual real estate they reside on, owners of cooperative housing are not eligible for reverse mortgages under FHA regulations. Reverse mortgages are further prohibited by state law in co-ops in New York, where they are widely used, and are only permitted in single- to four-family homes and condos.
2) Age, Fees and Equity :
Reverse mortgages do not have income or credit score criteria, but there are still guidelines for eligibility. You must have at least 62 years of age and sufficient equity (at least 50%) in your house, if not free and clear ownership. An origination charge, an upfront mortgage insurance premium, additional customary closing costs, recurring mortgage insurance premiums (MIPs), loan service fees, and interest are all fees that borrowers must pay. The amount that lenders can charge for several of these things is regulated by the federal government.
3) Counseling :
All prospective reverse mortgage borrowers are required by the U.S. Department of Housing and Urban Development (HUD) to complete a counselling session that has been approved by HUD. Given your particular financial and personal circumstances, this counselling session, which typically costs around $125, should last at least 90 minutes. It will go over the advantages and disadvantages of getting a reverse mortgage. It ought to detail how a reverse mortgage can affect your eligibility for Supplemental Security Income and Medicaid. The counsellor ought to go over the many ways you can get the money as well.
4) Collateral Protection :
The reverse mortgage regulations require you to maintain current homeowner's insurance, property taxes, and (if applicable) homeowners association dues in addition to maintaining the home's condition. Additionally, you will be required to return the loan, which is typically done by selling the house, if you stop residing in the home for a period of time longer than a year, even if it's because you need to live in a long-term care facility for medical reasons.
Who is a Reverse Mortgage Right For ?
To qualify, you don't need to have a job or good credit, and you won't have to make any loan payments as long as you live there as your permanent residence. A reverse mortgage is the only method to access home equity without selling the property, for seniors who :
- Unable to pay a loan's monthly payment.
- Don't want to be in charge of paying a loan's monthly payment.
- Because of a lack of cash flow or bad credit, you cannot be approved for a cash-out refinance or a home equity loan.
What is the Costs of a Reverse Mortgage ?
In October 2017, HUD adjusted the insurance rates for reverse mortgages. The insurance premiums establish a pool of funds that lenders can draw from so that they do not lose money when this occurs because lenders cannot force homeowners or their heirs to pay up if the loan balance gets bigger than the home's value. One adjustment was an increase in the up-front premium for three of the four borrowers from 0.5% to 2.0% and a drop in the up-front premium for the fourth borrower from 2.5% to 2.0%.
Previously, the upfront fee was based on how much money borrowers borrowed in the first year, with higher rates applied to homeowners who borrowed the most money to pay down an existing mortgage. All borrowers currently pay the same rate of 2.0%. The upfront premium is dependent on the home's worth, so you pay $2,000 for every $100,000 in evaluated value. On a $300,000 house, for instance, that comes to $6,000. In actuality, even if your house is worth more, the cost is only set at $6,000.
All borrowers are also required to pay annual MIPs of 0.5% (formerly 1.25%) of the borrowed amount. For every $100,000 borrowed, this modification saves borrowers $750 year, which helps to make up for the increased upfront price. Additionally, it means that the borrower's debt will increase more gradually, protecting more of the homeowner's equity over time, giving them a source of income later in life, and raising the likelihood that they will be able to pass the house on to their heirs.
Interest Rates of Reverse Mortgage
The only reverse mortgage with a fixed interest rate is the lump sum reverse mortgage, which pays you the entire amount all at once when your loan closes. The five other alternatives all offer changeable interest rates, which makes sense given that you're taking out a loan over a period of time rather than everything at once and that interest rates are constantly fluctuating. Reverse mortgages with variable rates are correlated to an index, frequently the Constant Maturity Treasury (CMT) index.
The lender adds a buffer of one to three percentage points to one of the base rates. Your reverse mortgage's interest rate will be 4.5% if the index rate is 2.5% and the lender's margin is 2%. Your credit score has no bearing on the reverse mortgage rate or your eligibility because interest accumulates over the course of the loan.
How Much Can You Borrow with Reverse Mortgage ?
The lender and your payment schedule will both have an impact on the amount of money you'll get from a reverse mortgage. The youngest borrower's age, the interest rate of the loan, and the lesser of your home's appraised value or the FHA's maximum claim amount will all be taken into account when determining how much you can borrow under a HECM.
You cannot borrow all or even close to the value of your home. Your home equity must be utilized in part to cover the costs of the loan, such as interest and mortgage insurance. You should also be aware of the following information on the maximum amount you can borrow :
- You can borrow more money with a lower mortgage rate.
- You can borrow more money if your property's appraised worth is higher.
- The youngest borrower's age, or if the borrower is married, the younger spouse, even if the younger spouse is not a borrower, determines the loan proceeds. The loan proceeds increase with the youngest borrower's age.
- Because the lender won't withhold a portion of the funds to pay your homeowners insurance and property taxes, a strong reverse mortgage financial evaluation boosts the amount you'll receive.
How to Apply for a Reverse Mortgage ?
An FHA-approved lender or another lender will accept your application for a reverse mortgage. Your borrower and property eligibility for the loan is reviewed by the lender. In a marriage, at least one partner must be 62 or older.
Your home is compared to recent sales in the area by a licensed appraiser. The loan is then processed for the necessary paperwork and underwriting to confirm your income, assets, credit history, and monthly living costs. This is done to make sure you have paid the necessary taxes and insurance premiums. Your ability to withdraw equity is determined by :
- Your age (older people qualify for more)
- Interest rate (lower interest rates lead to higher amounts)
- Lesser of $1,089,300 in 2023, the appraised value or the sales price.
You can select a set interest rate, a monthly or yearly changing interest rate, or a variety of payment plans for your amount and interest rates. The options that are possible include a single payment made all at once, monthly payments for a predetermined amount of time, or for as long as you own the house.
You get the reverse mortgage money once you sign the closing documents. You must first use the money to pay off your mortgage if you still have one. For as long as the reverse mortgage agreement permits, you will continue to receive payments.
The loan is repaid at the end of the period, which could be when you sell the house, when you pass away, or when the loan term expires. It might also be due if you enter a nursing home, convalescent home, or assisted-living facility because you need long-term care. In most of these situations, the house is sold, and the money from the sale is used to repay the loan.
Note :
The Consumer Financial Protection Bureau (CFPB) cautions homeowners against reverse mortgage scams, which can prey on elderly victims and attempt to trick them into giving away money.
Types of Reverse Mortgage Lenders
Three varieties of reverse mortgages, created by various lenders, are available on the market.
1) FHA-Approved Lenders :
The only reverse mortgage product that the U.S. Department of Housing and Urban Development federally insures is the Home Equity Conversion Mortgage (HECM), which can be used for any purpose. Lenders that have been approved by the Federal Housing Administration can offer this sort of loan.
One- to four-family homes, single-family homes, condominiums with HUD approval, and manufactured homes with FHA approval are all examples of eligible real estate. To be eligible for a HECM, you must :
- Older than 62 years of age
- Occupy the subject property as your primary residence
- Own your home outright or just owe a small mortgage
- Have no past-due federal debt
Borrowers must contact connected organizations to schedule in-person and telephone HECM counselling sessions as required by HUD. An average rate for counselling services is $125. Call (800) 569-4287 or visit the HUD website to find a counsellor in your area.
2) Banks and Private Mortgage Lenders :
Exclusive reverse mortgages are created and provided by financial organizations and registered lenders. Jumbo reverse mortgages are a type of loan that homeowners with high-value residences are frequently eligible for. Not all localities offer proprietary reverse mortgages.
3) Single-Purpose Reverse Mortgage Lenders :
Reverse mortgages with a specific purpose are provided by several local, state, and charity organizations. The least expensive reverse mortgage loan option, however it can only be used for a specific, predetermined purpose. For instance, the lender can stipulate that the borrower can only spend the money for property taxes or house upgrades. Homeowners frequently need to make less money than a certain amount in order to be eligible for this kind of reverse mortgage.
How to Get a Reverse Mortgage ?
You must submit a Residential Loan Application for Reverse Mortgages once you have located a lender. As part of the application, you must submit :
- Information on the property, including the address, estimated value, construction year, and dwelling type of your home.
- Information about the borrower, such as specifics about your possessions and earnings, your name, address, and Social Security number.
- Details regarding any liens placed on the property.
- Supporting records including bank and portfolio statements, appraisals, and bank statements.
Lenders have different loan procedures. To speak with a loan officer, you must either phone a toll-free number or complete a brief online eligibility form. The loan officer will send you an application package to fill out and return if you are approved.
Note :
You are free to cancel a reverse mortgage within three business days after closing according to a federal statute known as the three-day cancellation rule. Send a letter of cancellation to the lender via certified mail and include a return receipt.
Advantages of Reverse Mortgage
1) Cash flow :
Your accrued home equity may provide you with the resources you need to maintain your independence and avoid running out of money throughout retirement.
2) Non-taxable income :
The income from a reverse mortgage is typically not taxed, however you should consult a tax expert to be sure.
3) Stay in home :
You don't need to worry about making monthly mortgage payments if you pay off your current mortgage and stay in your property.
Disadvantages of Reverse Mortgage
1) Possibly losing your home :
Home upkeep, real estate taxes, and insurance costs are still your responsibility. You're still obligated to pay property taxes and keep up the house, just as with any other mortgage.
2) Heirs may inherit less :
You are going back in time with respect to accrued equity. The house must be sold to cover those debts, but any money left over can be added to the estate.
3) Income can impact benefits :
Any needs-based services you are eligible for, like Medicaid, could be affected by money you get through a reverse mortgage but do not use in the same month.
4) When the loan is due, the balance can be more than expected :
Due to the higher interest rates associated with reverse mortgages, your lender will continue to charge interest even though you are receiving payments each month. You might owe more than you anticipated when your reverse mortgage is due.
Frequently Asked Questions
Is a Reverse Mortgage Expensive?
The most popular form of reverse mortgages, home equity conversion mortgages (HECMs), come with a range of upfront expenditures and continuing expenses. The biggest of these, together with the interest the borrower accrues on the loan balance, are origination fees, closing charges, and mortgage insurance premiums.
What is the downside to a reverse mortgage?
A reverse mortgage's drawback is that it frequently has high interest rates and closing charges, which can make it very expensive to repay when the loan is due. Additionally, the reverse mortgage loan must be paid back as soon as possible if you vacate the property or pass away.
How is a reverse mortgage repay?
You can repay a reverse mortgage in full when it is due by selling your property and utilizing the proceeds to cover the loan, regardless of whether you relocate, die, sell the house, or the term has run out. You could also be able to convert the reverse mortgage into a regular mortgage and pay the new loan off over time with regular payments.
With a reverse mortgage, is it possible to owe more than the property is worth?
Lenders cannot pursue borrowers or their heirs if the home turns out to be underwater when the loan comes due, even if your loan total rises above the value of your home. Borrowers' payments for mortgage insurance go into a fund that compensates lenders for their losses in this scenario.
Can a reverse mortgage be refinanced?
Refinancing a reverse mortgage is possible. Refinancing a reverse mortgage should only be done in circumstances where a spouse needs to be added to the loan, additional equity is required, or the interest rate can be significantly reduced due to the origination charge, upfront mortgage insurance payment, and other closing fees.
How do reverse mortgage lenders generate revenue?
Closing charges and other fees are assessed by reverse mortgage lenders. Some lenders will also charge you for insurance costs when you use HECMs. In addition, interest is charged on reverse mortgages, and this interest builds up over the course of the loan.
When do you have to repay reverse mortgage?
If the borrower undertakes any of the following, the lender will demand repayment of the reverse mortgage :
- Sold the house
- Passes away
- Lives more than a year away from home
- Fail to maintain the house
- Stop paying your property taxes or homeowners insurance premiums
For qualified non-borrowing spouses who desire to continue residing in the home after their borrowing spouse passes away, there are some exceptions to these requirements.
How to avoid reverse mortgage foreclosure ?
A reverse mortgage's potential for foreclosure is another risk it entails. The borrower must satisfy certain requirements in order to qualify for a reverse mortgage, even though they are not responsible for any mortgage payments and cannot fall behind on them. The lender may foreclose if these conditions are not met. You must reside in the property and keep it up as a reverse mortgage borrower. When it comes time to sell the house, it won't be worth fair market value, and the lender won't be able to get back the full amount it provided to the borrower if the house is in disrepair.