What are the Benefits of Reverse Mortgages?
What are the Benefits of Reverse Mortgages
The Benefits of Reverse Mortgages
We hear a lot about reverse mortgages for seniors and this is often associated with negative news items about people being ripped off and losing money. However, for some seniors, a reverse mortgage can be beneficial. We take a look here at what reverse mortgages are and the pros and cons associated with them.
A reverse mortgage is another form of loan that is available to those with a good amount of equity in their home. To take advantage of this you must be aged 62 or above. Most of these mortgages benefit from federal insurance but there have been several scams associated with this type of loan so be aware and take advice from a reputable professional before signing any documentation. You must understand how these loans work and what the implications of them are for yourself and your family.
What is the difference between this and an ordinary mortgage?
With reverse mortgages, the borrower does not pay anything to the lender but upon their death the entire loan becomes payable. Federal law demands that a lender does not allow an individual to borrow more than the value of the home and that there will be no liability from the estate if it does increase beyond this value. However, this can happen if the borrower lives for many years after taking out the loan or if the market value of the home drops substantially.
How does reverse mortgage work?
With a reverse mortgage, the equity tied up in the home is released and is paid to the homeowner either as a cash lump sum, monthly payments, or periodic advances. These funds are not taxed by the IRS because they are classed as a loan rather than income.
The most common type of reverse mortgage is the HECM (Home Equity Conversion Mortgage). If your home is worth under $679,650 this is the one you will get, if it is worth more you can look into something called a proprietary reverse mortgage. However, the HECM is the most common so we will focus on this.
When you are accepted for a HECM you can choose to have your money in several ways:
- Lump-Sum: Available with fixed interest rates only. This gives you all the funds as soon as your loan closes.
- Annuity: This provides a monthly payment for as long as one of the borrower resides in the home. This can be obtained with fixed or variable interest rates.
- Term Payments: This provides a set number of equal payments for a set period eg, over 10 years.
- Line of credit: The borrower can take the money as they needed it and only pay interest on the amount borrowed.
You can also opt for a combination of one or more of these methods.
Most lenders ask for a minimum of 50% equity before they will consider you for a reverse mortgage. Once you get the loan your mortgage will be paid off. There is no impact on your FICO score from this type of loan.
The costs of reverse mortgages
Just like any other loan the borrower will be expected to pay fees. There are no standard charges so the fee will depend on the lender but usually, fees are pretty high and are rolled into the loan. The fees cover such items as:
- Mortgage insurance premium – to cover any potential loss to the lender
- Lender fee – usually to cover the disbursements under the loan
- Application fees – these can be high so be wary.
- Closing costs – all of the costs associated with escrow, title policies, and so on
About interest rates
Apart from the lump-sum option all of the others have variable interest rates simply because you are taking the money over time, not as one lump. These are always tied LIBOR (the London Interbank Offered Rate). However, be aware that the lender will add their margin and this ranges between 1-3% so be sure to shop around to get the best possible deal.
How much money can you borrow?
This depends on your choice of loan program, what equity you have, and your age. Currently, the main originator of these types of loans is Wells Fargo but there are other programs available and how much you will receive will depend on the lender and how you plan to receive payments. Additionally, you will not receive 100% of your equity because it also has to cover the interest and other expenses.
Alongside this there are some other things to consider:
- The age of the youngest borrower – the older the person the higher the proceeds you will receive from the loan.
- Marital status – the age of your spouse will count even if they are not personally taking out the loan.
- If the mortgage rate is low you can borrow more.
- No funds are withheld to pay for homeowners insurance or property taxes (these will remain your responsibility).
Here are a few other things you need to know about how much you can borrow:
- The loan proceeds are based on the age of the youngest borrower or, if the borrower is married, the younger spouse, even if the younger spouse is not a borrower. The older the youngest borrower is, the higher the loan proceeds.
- The lower the mortgage rate, the more you can borrow.
- The higher your property’s appraised value, the more you can borrow.
- Recent changes in the law mean that some people find it harder to take out a reverse mortgage but these have also meant that homeowners that do qualify can keep more of their equity.
- You can only take up to 60% of your principal unless you are paying off the mortgage.
- Upfront lump sums mean you will not receive any more payments
- Line of credit – the amount available will grow if funds remain in the line.
The whole issue of reverse mortgages is a complex one and we strongly advise you to take professional, impartial advice.
Should you consider a reverse mortgage?
A reverse mortgage shares certain similarities with other loans and lines of credit. It can give you access to a lump sum or credit that you can access as and when needed. However, the main difference is that you don’t need to worry about an income or a good credit score to get a reverse mortgage. The qualifying factors for a reverse mortgage are:
- Aged over 62
- Minimum of 50% equity in your home
- The home is your primary residence
Let’s look at some of the pros and cons of taking out a reverse mortgage.
Reverse mortgages – the advantages
- It’s a good way to access cash if you need money for living expenses and you have no other assets.
- You can stay in your own home (but must pay all property taxes, insurance, and maintenance costs).
- You can go into a nursing home/assisted living facility for up to 12 months without affecting the loan.
Reverse mortgages – the disadvantages
The main disadvantages of this type of loan occur after the borrower has passed away. This to take into account here include:
- You will lose a lot of equity paying off the interest and loan fees when you pass away.
- You probably won’t have much left to hand down when you pass.
- If someone lives with you they will not be able to stay in the house once you pass away.
- If you need long term care (over 12 months) you will have to sell the home to repay the loan.
Another significant factor to consider is what happens if you outlive the equity you released with the reverse-mortgage loans? To offset this risk look at plans that provide a lifetime income, otherwise, you may run out of money just when you most need it.
Reverse Mortgages – Special Rules
The Federal Housing Administration (FHA) has specific rules regarding who can and can’t take out a reverse mortgage. Those seniors who own a home, condo, or townhouse or a manufactured home built after 15 June 1976 can apply for a reverse mortgage. However, if you own cooperative housing the FHA deems you to own shares in a corporation rather than real estate, rendering the property ineligible for this type of loan. This is particularly relevant in New York where there is a higher than average rate of cooperative housing.
There are federal limits on the fees that lenders can charge for originating the loans, insurance, servicing fees, and interest charges. Additionally, if the home is in poor condition when the borrower passes away the lender must give the family several months to look at their options.
HUD rules state that anyone wanting to take out this type of mortgage must receive counseling in one of their approved sessions. This discusses how this type of mortgage can impact the borrower including the effects on Medicaid or Supplementary Security Income entitlements.
Where can I take out a Reverse Mortgage?
A reverse mortgage is a specialty financial product and there are only a few lenders who deal with them. Always get several quotes and look carefully at the terms and fees because despite FHA rules there is still plenty of leeway for the lender. The biggest companies dealing with this type of product include:
- American Advisors Group
- One Reverse Mortgage
- Liberty Home Equity Solutions.
How reverse mortgages affects your spouse and/or heirs
If you are married your spouse will need to consent before you get a reverse mortgage loan. However, if their name is not on the loan they could be forced to sell the house if you pass away because the loan must be repaid upon the death of the borrower. If the surviving spouse is not named as a borrower they will have to find a way to pay the loan if they wish to remain in their home.
The way around this is to take out the loan jointly, however, this is not permitted unless both spouses are the owner of the home, for example, if one spouse inherited the property or purchased it before they got married. The ideal situation is that both parties hold title to the property and both take out the loan. This way the surviving spouse can remain in their home if the other dies or has to go into a long-term care facility.
The risk of foreclosure
Although the borrower cannot be delinquent on mortgage payments the lender can foreclose if the borrower doesn’t meet all the requirements they agreed to when they signed up for the reverse mortgage. For example, failing to pay property taxes, homeowners insurance, or maintaining the property can lead to a lender foreclosing. This is so they can protect their interest in the property. The reality is that between 2009 and 2017 around 1 in 5 people had their reverse mortgage loans foreclosed.
Avoid being a victim of a reverse mortgage scam.
There have been some unscrupulous individuals who have targeted seniors looking for reverse mortgage loans. This is not surprising considering that these lucrative financial products are often sought by vulnerable people in a bad financial situation. There have been cases of contractors pushing seniors to take out these loans to pay for improvements to the home which, of course, they will then carry out. In return, they provide poor quality work or simply run off with the cash.
It has also been known for carers and relatives to take advantage of a power of attorney to remortgage a home often as a result of pressure from financial advisors whose interest is in their bank balance rather than that of the client. It pays to be wary of the risks of reverse mortgage loans.
Always use an approved lender
Go online to find out which approved lenders are available by checking with either the National Reserve Mortgage Lenders Association or the Department of Housing and Urban Development. Always limit your search to those who have completed a HECM loan in the last year.
Reverse mortgages can help seniors financially once they understand the benefits and risks so it is well worth taking some time to research these loans to find out how they work. In-depth research also helps seniors to avoid falling victims to any mortgage counselor that could offer bad advice.
Although a reverse mortgage can only be obtained through certain lenders it is still a complex issue so spending time on education is key.