What is a reverse mortgage?
Most home buyers applying for a loan know what a mortgage is, but a reverse mortgage may seem far less familiar. Maybe you've heard this mortgage term bandied about, and maybe have even seen the late-night TV ads promoting them. But people are often confused or all-out clueless on the details of this type of loan, so allow us to explain.
What is a reverse mortgage?
True to its name, this type of mortgage is the opposite of a traditional loan, where you borrow a couple of hundred thousand dollars for a mortgage from a lender and then slowly pay it back month by month—plus interest. In a reverse mortgage loan, your lender pays you, slowly turning the home equity you've earned back into cold, hard cash.
However, just because you qualify for this type of mortgage doesn't mean this loan option is a good idea for you. Read on to make sure you understand the risks and benefits, and how this will affect your home equity.
Who can get a reverse mortgage, and what are the benefits?
This type of mortgage is available to homeowners 62 and older, and can be useful for seniors searching for a loan who may not have much in terms of income or assets. A reverse mortgage taps into their home equity and increases the amount of money they have coming in to cover various living expenses.
"Ideal candidates are those who want to stay in their home, owe little to nothing on it, and need more cash," says Debbie Worley, president and loan officer at Lone Star Reverse Mortgage in Horseshoe Bay, TX.
The mortgage loan must be repaid when the last borrower, co-borrower, or eligible spouse sells the home, moves, or dies.
What is a Home Equity Conversion Mortgage (HECM)?
The HECM is the reverse mortgage program offered by the FHA. HECM enables homeowners to withdraw some of the equity in their home. The borrower has the power to decide how the funds are withdrawn—either in a fixed monthly amount, a line of credit, or a combination of the two.
To take advantage of HECM, you must be 62 years of age or older, own the property or have a low mortgage balance, be living in the house as your primary residence, not be delinquent on any federal debt, meet with an approved HECM counselor.
HCEM is available only through a lender that has been approved by the FHA.
Interested in the HECM program? Visit the Department of Housing and Urban Development website.
How much money can I get for a reverse mortgage?
Most people are wondering, what is this type of loan really going to do for me? The amount you can qualify for is known as the initial principal limit (IPL). The IPL of a mortgage is determined by combining a home's value, the homeowner's age, the type of loan, and the interest rate. It's rarely more than about 60% of the home's value—and it tops out at $625,500.
There are a variety of ways you can receive money from this type of mortgage. The standard loan disbursement options include the following:
Lump sum: You get a large chunk of money (though you can't access all of your equity at once).
Term: The borrower receives monthly payments for a fixed amount of time.
Tenure: The borrower receives monthly mortgage payments guaranteed to last until she dies or moves.
Line of credit: The loan amount can be accessed whenever the mortgage borrower needs money. And the sum grows in value, not due to interest but the assumption that the home appreciates with time.
Modified tenure/term: A combination of access to a line of credit and term or tenure monthly payments of your loan.
When does the mortgage need to be paid back?
A reverse mortgage can become due if the borrower fails to pay homeowners insurance or real estate taxes on the loan. But what's more likely is that the borrower moves out or dies—that's when a mortgage's outstanding balance needs to be paid off, says Warren A. Ward at WWA Planning & Investments.
In the case of death, the remaining mortgage equity goes into the estate. The heirs can still inherit the home as long as the loan is in good standing; in fact, if the heirs make the home their primary residence and meet the loan terms, the mortgage can continue in their name.
The risks of reverse mortgages
In spite of these advantages, reverse mortgages have a bit of a sketchy reputation, largely due to misleading claims made by unscrupulous lenders. In the past, if only one member of a married couple put his or her name on the mortgage—and that spouse died—the surviving spouse could face foreclosure if they default on the loan.
Luckily, new laws and safety measures mandate that the surviving spouse cannot be kicked out.
But even though regulations and safety measures surrounding reverse mortgages have improved, these loans still have some sizable drawbacks. For one, they tend to have worse terms than other means of tapping your property's value, like home equity lines of credit. Plus, the fees associated with this type of mortgage can rip through a homeowner’s equity quickly.
For instance, an origination fee on this type of mortgage can amount to a whopping 2% of the initial $200,000 of the home's value, and 1% of the remaining value, with a cap of $6,000.
Also, when looking into this type of loan, keep this simple fact in mind: You're basically borrowing money from yourself. Meanwhile, your lender is slowly nibbling away at the equity you've earned in your home. If you dream of leaving your home to your kids, you should think long and hard before you move forward with a reverse mortgage.
So even if turning your home into an ATM sounds tempting, think through various life scenarios before committing to a reverse mortgage. Shop around to get the right mortgage product, and check to see if a mortgage lender has had any complaints from past borrowers.
Because this type of loan can be complex, housing counseling is a must. The National Council on Aging offers counseling through its Reverse Mortgage Counseling Services Network, one of nine national counseling groups approved by the U.S. Department of Housing and Urban Development. There is an upfront fee of $135 for this service (which can be deferred depending on your budget).