Unexpected illnesses and other expenses can occur at any time. Because they are often in their retirement years, the senior population is especially susceptible. In an emergency, when a senior needs cash but all they have is equity in their home, a reverse mortgage can make up the difference between what they have and what they need.
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What Is a Reverse Mortgage?
A reverse mortgage is essentially a loan for a homeowner over the age of 62. The ideal candidate requires cash and has substantial equity in their home.
The borrower can take out a reverse mortgage on their home and receive access to their home’s equity as a line of credit, monthly payments, a check for the lump sum, or a combination of those options. Instead of paying the loan back monthly or as a lump sum, the borrower pays the lender back when they die, sell the home, or move out permanently.
How Do Reverse Mortgages Work?
In a typical reverse mortgage, the lender pays the homeowner, and the homeowner determines how they would like to receive the payments. In contrast, traditional mortgages require the recipient to pay back the lender over time.
The homeowner is only responsible for paying property taxes and homeowners insurance. Therefore, the homeowner doesn’t make any payments until the loan is due in full. Similar to a traditional mortgage, the equity in the home decreases while the loan balance increases.
The homeowner keeps the title, but the home serves as collateral for the life of the loan. The loan amount is due in full once the homeowner dies, permanently moves, or stops paying the insurance and taxes on the home.
Types of Reverse Mortgages
There are several types of reverse mortgages that borrowers may qualify for:
Home Equity Conversion Mortgage (HECM)
HECM is a type of mortgage insured by the FHA and is the most frequently used type of reverse mortgage for borrowers. For this type of reverse mortgage, homeowners over the age of 62 and with considerable equity in their homes, at least 50%, can gain access to equity through a lender.
The lender assesses the value of the borrower’s home and the borrower’s stake in the house and offers them a line of credit, a check, or monthly payments up to their limit. The borrower, in turn, doesn’t have to pay the loan back until they die, sell the property, or move out permanently.
Proprietary Reverse Mortgage
Also called a jumbo reverse mortgage, This type of reverse mortgage is for seniors with homes worth more than a traditional HECM will give them access to. According to the National Reverse Mortgage Lenders Association, Congress increased the HECM upper limit to $970,800 in 2022.
Single-Purpose Reverse Mortgage
This is the most cost-effective and least common loan issued to borrowers. The purpose of such a loan is usually to repay a single, lender-approved debt, such as a tax debt or improvement on a home. The most significant difference with this mortgage is it can only be used for one lender-approved purpose.
Reverse Mortgage Requirements
The following is a list of requirements for a borrower to obtain a reverse mortgage:
- The dwelling has to be either a manufactured home built after June 15, 1976, a house, a condominium, or a townhouse.
- The applicant must be at least 62 years of age.
- The applicant must have at least 50% equity in the home.
- The applicant must pay an origination fee, inspection fees, standard closing costs, title fees, and an upfront mortgage insurance premium
- The applicants are required to sit for a 90-minute counseling session.
- The applicants must keep the taxes, property insurance, and homeowners association fees on the home and keep the house in good condition.
Cost of a Reverse Mortgage
All borrowers must pay 2% of the home’s value upfront and .5% of the amount borrowed for the monthly mortgage insurance premium. The lump sum is the only payment type with a single interest rate. Because the borrower borrows funds with these payment options for several years, the interest rates for the other payment options can fluctuate from year to year.
A loan applicant’s credit score does not affect their approval. However, their credit might cause the bank to secure a Life Expectancy Set Aside account for insurance, taxes, and other property expenses.
Using a Reverse Mortgage
The borrower’s method of using the funds from a reverse mortgage depends on the type of reverse mortgage they secure. For a single-purpose reverse mortgage, the lender and the borrower must agree on using the reverse mortgage funding. The options for a HECM or proprietary reverse mortgage are broad, and the borrower can use them as they see fit.
Advantages and Disadvantages of Reverse Mortgages
There are several advantages and disadvantages to securing a reverse mortgage. A few of them are as follows:
- A reverse mortgage provides borrowers with cash for unexpected bills.
- The borrower pays nothing back until they sell the house, move out, or die.
- The loan includes almost all fees and interest.
- The applicant and their family are only responsible for the loan amount equal to the home’s value. If property values decrease and cause the loan amount to be higher than the home, the borrower and their family only have to pay the loan back up to the house’s value.
- Reverse mortgages have competitive interest rates.
- The applicant keeps the deed to their home while accessing the cash they’ve put into owning it.
- The total loan costs, including fees and interest rates, can be extensive.
- The estate must repay the loan before the home will pass to the heirs.
- The applicant must have at least 50% equity in the home.
- The borrower will pay mortgage insurance even though they previously weren’t responsible for it.
- The applicant loses the equity in the home.
Reverse Mortgage Risks
There is always a risk of foreclosure and seizure by the bank if the borrower finds themself living elsewhere for a significant period. Hazards include inpatient hospital stays and treatment in long-term care facilities.
If the borrower leaves the property for a time that the bank feels violates their reverse mortgage agreement, the bank can then seize the property and evict the non-borrowers while the borrower is away. The bank can also foreclose on the borrower if they feel they’ve let the home slip into disrepair or failed to pay the property taxes, homeowners insurance, and association fees.
Who Should Consider Reverse Mortgages?
A reverse mortgage would work best for those qualifying seniors who struggle to:
- qualify for a home equity loan or line of credit
- refinance due to poor credit or limited liquid assets
- make monthly loan payments
- rebuild depleted savings or have encountered substantial costs late in life
- maintain liquid funds but have significant equity in their home
- find a trustworthy lender or a reputable loan program
Reverse mortgages can come in handy for particular cash-strapped seniors. But because of the loss in equity for one of the most significant assets most retirees carry in their portfolios, seniors should consider whether the costs are worth the benefits.