While a “reverse mortgage” may sound like an oxymoron, it is a very real niche form of financing reserved for homeowners aged 62 or older. The first Federal Housing Authority (FHA)-insured reverse mortgage through the U.S. Department of Housing and Urban Development (HUD) debuted in 1989 and since then, older people have used reverse mortgages as a way to leverage home equity as an income source. As opposed to a traditional home mortgage in which you borrow money outright, with a reverse mortgage, a homeowner borrows against a home’s equity in exchange for cash. The loan, including accrued interest and fees, is not repaid until the house is sold or the borrower dies, at which point the homeowner’s beneficiaries can opt to repay the loan (and reclaim ownership of the house), sell the home, or do nothing, resulting in foreclosure.
With a reverse mortgage, the borrower’s amount of home equity decreases during the life of the loan while the amount of interest owed increases. There are several types of payment terms to consider for a reverse mortgage, including a single lump sum, monthly payments, a line of credit (allowing the user to withdraw money as needed) or some combination of those options.
The most common reverse mortgages are the FHA-backed loans offered through HUD, known as Home Equity Conversion Mortgages (HECMs). Additional types include single-purpose reverse mortgages — which are not offered everywhere and which limit the funds received to one use — and proprietary reverse mortgages, which are secured by private companies.
How much equity do you need to get a reverse mortgage?
While the amount of equity required may differ by lender and location, a typical minimum equity requirement is 50%. The requirement for a HECM is listed as someone who owns his or her home outright or has paid down a “considerable amount.” However, in essence you need 50% equity because a HECM requires you to use the reverse mortgage money to first pay down any remaining balance on your original mortgage. If you have less than 50% equity in your home, the reverse mortgage financing won’t be enough to cover the gap.
Using a reverse mortgage calculator, here are examples of how much someone would receive from a reverse mortgage in two different scenarios:
Example 1: A 70-year-old woman owns a single-family home valued at $300,000 with no balance left on her mortgage, which means her equity is 100%. It’s estimated she could receive a lump sum as high as $145,902, or 48.6% of her home’s value.
Example 2: A 70-year-old man who lives in a single-family home valued at $250,000 has $65,000 remaining on his mortgage. He would be eligible for a sum as high as $56,085.
The more equity you have in your property and the less you owe on your current mortgage, the more money you’ll get.
Other requirements for getting a reverse mortgage
The terms of a HECM reverse mortgage are primarily determined by the age of the youngest borrower (generally, the older you are, the more money you may be able to get), the appraised value of the home in question and the creditworthiness of the borrower. And just like with any loan, current interest rates play a role, too.
There are several qualifications borrowers must meet to receive an HECM, including:
- All potential borrowers (including any partners, if applicable) must be at least 62 years old.
- The home in question must be the borrower’s primary residence.
- The borrower can’t be delinquent on any federal debt (such as student loans or HUD-insured loans).
- The borrower must have the financial ability to pay for additional housing-related expenses like property tax, insurance, maintenance and homeowners association fees.
- Borrowers must participate in a consumer information session led by a HUD-approved HECM counselor. A list of approved lenders is available through the HUD website. There is typically a fee (around $125) for these sessions.
- The property must meet FHA standards and be either a single-family home or a two- to four-unit home with one unit occupied by the borrower, an HUD-approved condominium project, or a manufactured home that meets FHA requirements.
In October 2017, HUD made three changes to the HECM program. These updates, which grandfathered in existing reverse-mortgage holders, may keep the program viable through stricter regulations, some of which may also save certain borrowers money in fees, but they also reduced the amount a homeowner can borrow. The changes are the following:
- A flat 2% rate for mortgage insurance premiums (MIP): This move is beneficial for those taking more than 60% of the loan proceeds upfront, who previously would have had to pay an upfront premium of 2.5% of the value of their home in exchange for the lump-sum option. For those seeking smaller (below 60%) loan amounts, this upfront fee is now higher than the previous 0.5% fee.
- Reduced ongoing borrowing costs: The annual MIP borrowers will pay over the course of their loans has been reduced to 0.5% from 1.25%.
- Principal limit factor changes: This is the most complex change HUD implemented, but essentially it means that due to a lowered interest-rate floor, borrowers likely will end up paying less in total fees but also will be able to borrow less money overall.
Are there other options?
For seniors who don’t qualify for a reverse mortgage or who don’t think it’s the right choice for their financial future, there are other options that can help keep you financially comfortable.
- A home equity loan or home equity line of credit (HELOC): Similar to a reverse mortgage, a home equity loan or HELOC allow a homeowner to convert a portion of their home equity into cash, which can be used for house repairs, medical expenses, cash flow in retirement or other expenses. Qualifying for one of these products requires a credit check and results in recurring monthly payments, but you’ll still own your home and only pay interest on the amount you borrow.
- Cash-out refinance: Depending on your current interest rate and the interest-rate environment, a refinance could reduce the monthly mortgage payment or generate a lump sum in cash. Again, your home remains a beneficial asset for you and your heirs. Unlike a reverse mortgage, however, the monthly payments do not go away.
- Downsizing: You may opt to sell your home outright in favor of a smaller, less-expensive property and a lump sum of cash from the proceeds.
- Selling to a loved one: Some senior homeowners opt to strike a deal with their children or other heirs; they sell below the market price but stay in the home for a predetermined period of time.
There are several risks associated with reverse mortgages that potential borrowers should be aware of before beginning the application process.
- Fees: To take out a reverse mortgage, you’ll typically need to pay closing costs, the 2% MIP and a loan origination fee. These upfront costs can be thousands of dollars, which is a modest dent in any accrued home equity.
- The impact of interest rates: While a single lump sum typically has a fixed interest rate, other payment options have a variable-rate structure. The higher the interest rate, the quicker the equity will depreciate.
- Potential loss of home equity: Because a reverse mortgage monetizes the equity you have built in your home, it can deplete this equity and gradually transfer ownership of the property back to the lender. Those with a goal of passing along their home to children or a charity may not want to consider a reverse mortgage.
- Loss of tax deductions: Interest on reverse mortgages is not tax-deductible.
Reverse mortgages are not the right option for every senior homeowner, but they do make sense in some circumstances. The important factor to mull over before you move forward is how much benefit you will get from exchanging equity in your home for liquid cash.
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