Reverse Mortgages Explained – All The Why’s, When’s And How’s
We all have heard about reverse mortgages, but the truth is that this particular type of mortgage works in a way no other mortgage does, so you may want to take a deeper look.
In this article, you’ll find everything you need to know before signing up for a reverse mortgage. Let’s get to it!
What Is A Reverse Mortgage?
A specific type of mortgage is available only for senior citizens over 62 years old, who have considerable home equity.
It is called a reverse mortgage because instead of you paying money, you will just receive it:
● In a lump sum
● As a fixed monthly payment
● As a line of credit
Unlike any other mortgage, the borrower doesn’t make any payments. That’s because the loan balance becomes payable when the homeowner dies, moves out permanently, or sells the house.
How Do Reverse Mortgages Work
As we know by now, on a reverse mortgage, instead of making payments to the lender, the lender makes payments to you. You can choose if you want the money in a lump sum, as a line of credit, or as a fixed monthly payment. All the interests and expenses will be rolled into the loan balance so you don’t have to pay anything upfront.
How Do You Pay Back A Reverse Mortgage?
Once the homeowner dies, decides to move out of the house for good, or sell it, the proceeds from selling the house will cover the loan and interests. During all this process, the homeowner keeps the title to the home, although its debt increases and home equity decreases.
Just as with any other type of mortgage, the house becomes the collateral. And if the proceeds from selling the house exceed the debt amount, those funds will go to the homeowner (if still lives) or their estate. Sometimes the remaining family can choose to pay off the mortgage so they can keep the house.
Types Of Reverse Mortgages
The three main types of reverse mortgages are:
● Single-purpose reverse mortgages
● Home-equity conversion mortgage (Federally-insured reverse mortgages)
● Proprietary reverse mortgages
Most people use a reverse mortgage loan to pay off previous mortgages, pay for health care expenses, or to supplement their current income.
● Single Purpose Reverse Mortgages
This is a loan that can be provided by the state, local or non-profit agencies. And is one of the less expensive options for a reverse mortgage.
These loans are single-purposed. That means the lender specifies the reason for the loan. As a homeowner, you can use a single-purpose reverse mortgage only to pay for a specific purpose, such as property taxes, or home repairs.
While lenders can restrict how the proceeds of the loan should be used, a reverse mortgage does not have to be repaid unless the house is sold, the borrower moves out permanently, or passes away. Single-purpose reverse mortgages will also become due if the city condemns the property, or the owner stops maintaining the homeowner’s insurance.
On a reverse mortgage, borrowers don’t need to make any payments until it’s due, however, you should keep in mind that mortgage insurance, fees, and interests can reduce the amount you can borrow.
● Home-equity Conversion Mortgage
They are also known as Federally-insured reverse mortgages. That’s because they are backed by the Department of Housing and Urban Development.
Home equity conversion mortgages tend to be more expensive than single-purpose reverse mortgages, and sometimes they come with high upfront costs. Even with that, this is the most widely used type of reverse mortgage loan.
The main reason for that is there are fewer limitations and you can use the loan for whatever reason you want.
Borrowers are required to take a counseling season before applying. This way they can be fully aware of payment options, costs, and responsibilities involved in the home equity conversion mortgage.
During these counseling seasons, borrowers are educated about other non-profit or government-issued options available, and they learn how to choose the one that best suits them. These counseling sessions have a cost, but in most cases, you can pay it from your loan proceeds.
Your lender will then evaluate your age, the value of the house, and the interest rate to come up with an amount you can borrow. Older senior citizens with higher home equity will be provided with bigger amounts.
You have some options to receive the proceeds:
❖ As a term option that allots monthly cash advances
❖ A tenure option to receive advances for as long as the house is your primary residence
❖ A credit line you can withdraw from anytime
You can also get a credit line coupled with monthñy payments, and in most cases, you can change the payment option with a small fee.
● Proprietary Reverse Mortgage
A proprietary reverse mortgage can provide you with larger sums than regular mortgages. The reason is these types of loans are only available for houses appraised at a higher value than the Home Equity Conversion Mortgage limits set up by the U.S. Department of Housing and Urban Development.
Up to 2021, the HCM loan limit is $822,375. If your property value goes over that you may be eligible for a higher loan with a proprietary Reverse Mortgage.
Some lenders require borrowers to take a counseling session before applying. A counselor can help you determine which option offers better costs and benefits, and help you evaluate if a proprietary reverse mortgage is right for you.
And since proprietary reverse mortgages are not federally insured, you don’t need to pay for mortgage insurance premiums (MIP), allowing you to borrow even more.
So, how can you decide if what you need is a single-purpose reverse mortgage, a home-equity conversion mortgage, or a proprietary reverse mortgage?
● Interest Rates
Keep in mind some lenders will charge an interest rate relative to the value of the house, which can decrease the borrowed amount substantially.
● Get To Know Your Pros And Cons
Some things like your age and a good FICO score can play in your favor, while low home equity or a red flag on your credit report can reduce the amount to borrow.
● Compare Your Options
Every lender is different, so you may need to go shopping around to find the one that best suits you.
● Open To More Alternatives
Maybe a home-equity line of credit could work better for you. If your house has a high value, have you considered downsizing and selling it?
Important Things To Know About Reverse Mortgages
Rules And Regulations
Even though there are no credit scores or income requirements, they still have some rules. You need:
● To be at least 62 years old
● Either owns the house free and clear or have home equity of at least 50%
● Pay an origination fee, insurance premiums, loan service fees, and interests
There are limits on how much lenders can charge you for those services, set by the Federal Government. Some lenders will allow you to roll those fees into the loan, reducing the borrowed amount, while others will require an up-front payment.
If the house turns out to be underwater when the mortgage is due, the lenders can not go after the borrower or the heirs.
When the homeowner dies, the lenders must provide several months to the heirs for them to decide if they want to repay the mortgage to keep the house or allow the lender to sell it.
All reverse mortgage borrowers are required by the Department of Housing and Urban Development to take a counseling session before signing in.
These sessions last about 90 minutes and usually cost around $125. Keep in mind most lenders will allow you to pay from the very same loan.
Some of the things you will be advised on are:
● The pros and cons of a reverse mortgage given your unique financial circumstances
● How your Supplemental Security Income and Medicaid eligibility may be affected
● The different ways you can receive the proceeds
● Your responsibilities (Such as stay up to date with property taxes and homeowners insurance)
Reverse Mortgages And Interest Rates
Most lenders and mortgage types have adjustable rates. The biggest exception is the lump-sum reverse mortgage, which typically offers a fixed rate.
This is because with most options you will be borrowing different amounts across time, and as you know, interest rates are always changing.
Reverse Mortgage Loan Amounts
The amount you can borrow depends on several factors, such as the lender, the mortgage type, and your home equity.
Technically you can borrow 100% of your home value, however, you need to keep in mind part of that sum will pay for loan expenses such as mortgage premiums, interests, or even the initial counseling session.
Here are some of the things that play to decide the amount you can borrow:
The proceeds of the loan are based on the age of the younger borrower (If there are more than one). The younger they are (the youngest co-borrower), the bigger the loan amount.
- A higher mortgage rate equals higher amounts you can borrow
- The higher the house is appraised, the more you can borrow
Spouses And Heirs
While both spouses have to sign in to consent to the loan, they don’t have to be both borrowers. You need to pay special attention to these details because the loan becomes due when the borrower dies, it doesn’t matter if their spouse is still living there, and usually, the only way out is to sell the house.
The ideal scenario is when both spouses are co-owners of the house and co-borrowers on the reverse mortgage. That way if one of them passes away, the other one can keep the house and the borrowed money for as long as they live in the house.
Fees Involved In A Reverse Mortgage
After the borrower passes away, the house balance can grow larger than the value of the house. To avoid losing money, lenders charge insurance premiums that provide them a pool of funds they can use to avoid losing money.
● Insurance premiums = 2% of the value of the house (paid up-front)
● Annual Mortgage Insurance Premiums = 0.05%
Potential Downsides To A Reverse Mortgage
One of the potential downsides to a reverse mortgage is the fact that you cannot stop living in your house for more than a year, even if it’s because of medical reasons. If you do so, the loan becomes due, and the borrower will be required to repay it. Which is usually accomplished by selling the house.
You must pay close attention before signing in because there are legitimate big risks on reverse mortgages. One of the biggest risks is the surviving widow or widower losing their home after the homeowner passes away.
Is A Reverse Mortgage The Best Option For Me?
A reverse mortgage can be one of the best options for seniors to access their home equity without selling the house. Also, a reverse mortgage doesn’t require them to make any monthly payments, which could be convenient for senior citizens who don’t have a regular job anymore.
Although, if you want to look for alternatives, a home equity loan or line of credit is another way to tap into your home equity.
And if you cannot seem to get approved for any of the above, you still can think of options such as downsizing and selling the house.
Things To Evaluate Before Getting A Reverse Mortgage
● A reverse mortgage could be a great way to turn your home equity into cash and to get enough money to meet your monthly expenses.
● You need to keep up to date with home maintenance, property taxes, and insurance.
● Keep in mind that the loan becomes due if you move into a retirement or assisted living facility for more than a year.
● Remember you will spend a considerable amount of that loan on interests and fees.
● Getting a reverse mortgage means you won’t be able to pass your home to your heirs.
● A problem many borrowers experience is to outlive their mortgage proceeds. That usually happens when they choose a lump sum instead of a term plan, but it also happens when borrowers take a line of credit and use it all up. That leaves them with no money left when they need it.
Things To Avoid On A Reverse Mortgage
● Beware Of Reverse Mortgage Scams
Reverse Mortgages can be a very lucrative business. And given that many borrowers may be older seniors with little to no knowledge about mortgages, there are a lot of unscrupulous vendors trying to take advantage.
There are home improvement contractors that try to engage senior homeowners into renewing a bathroom or a roof with “no money upfront”, using a reverse mortgage. They end up overcharging excessively and delivering -if any- low-quality work.
● There Is A Risk Of A Foreclosure On A Reverse Mortgage
Even though the borrower doesn’t need to make payments, they still have to follow certain conditions. You can be at risk of foreclosure if you
You cannot stop living in the house for more than a year (even if it’s to move into an assisted living facility)
● To give proper maintenance to the house
● Stay up to date with property taxes and homeowners insurance
Frequently Asked Questions About Reverse Mortgages
1. How Does A Reverse Mortgage Work When You Die?
Reverse mortgages become due when the homeowner dies and when they move out permanently from the house or decide to sell it. The bank (or institution that provided the loan) usually sells the house to get repaid.
2. How Do You Pay Back A Reverse Mortgage?
A reverse mortgage becomes due when the homeowner dies, so usually, there is no need to make any monthly payments.
3. How Much Money Do You Get From A Reverse Mortgage?
Technically you can borrow 100% of your home equity, but remember you still need to pay premiums, interests, and fees.
Also, your age and the value of the house (on an appraisal), play a role in the loan amount you can get.
4. Are Reverse Mortgages Safe?
Yes. But unfortunately, many unscrupulous vendors are trying to take advantage of the senior population. Also, keep an eye on house repair services that offer to improve your house at no cost. It’s usually a scam related to a reverse mortgage.
5. How Many Types Of Reverse Mortgages Are There?
There are three types:
● Single-purpose reverse mortgages
● Home Equity Conversion Mortgage
● Proprietary reverse mortgage
Closing
As you can see, reverse mortgages can be an excellent option for senior citizens who want to tap into their home equity. It is also a great way to increase their monthly income.
Remember this particular type of loan comes with a load of responsibilities and obligations, so make sure to take a close look at every single paper you sign.
If you want to know more about other mortgage options, take a look at this article about Home equity loans and lines of credit. “Home equity Loans”
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