How Does a Reverse Mortgage Work?
The financial outlook for America’s aging population can seem pretty bleak. More than 40% of baby boomers have no retirement savings, according to a study from the Insured Retirement Institute. Of the boomers who did manage to save for retirement, 38% have less than $100,000 — leaving many of them without the cash they’ll need.
And a lack of savings is not the only problem facing the aging population: Debt among 65-year-olds increased by 48% between 2003 and 2015 and most of the debt came from student loans. Well-meaning grandparents who cosigned on student loans to help their children or grandchildren defray the costs of higher education effectively increased their own student loan debt burden from $6.3 billion in 2004 to $85.4 billion in 2017.
However, there is a silver lining to this sobering story. Baby boomers own two out out every five homes in the U.S., with an estimated $13.5 trillion in value.The equity in these homes might be enough to bridge the savings gap and ease the debt burden by allowing seniors to access their home equity through a mortgage product called a reverse mortgage.
Home price increases since 2012 are providing more accessible equity for seniors in need of the flexibility of the reverse mortgage program to solve current financial problems, or prevent them from occurring in the future.
Here’s a guide to understanding reverse mortgage, how they work and whether they’re a right fit for you.
In this article, we will cover:
- The difference between a regular mortgage and a reverse mortgage
- How a reverse mortgage can help you
- Who qualifies for a reverse mortgage
- Changes to reverse mortgages in 2019
- Different types of types of reverse mortgages
- 5 ways to access your money using a reverse mortgage
- Disadvantages of a reverse mortgage
- How a reverse mortgage works after you close
- How reverse mortgage scams work and how not to be a victim
A traditional mortgage requires a monthly payment of principal and interest, and is sometimes called a “forward mortgage.” The entire amount is borrowed in one lump sum and is paid “forward” on a fixed monthly payment schedule until the balance is down to zero.
A reverse mortgage does just the opposite. Your balance increases over time as you access the equity stored up in your home.
After reviewing how much equity is in your home, a reverse mortgage lender will give you cash in a lump sum, as monthly income or a combination of both. You can use all of the equity you’re approved to borrow at once, or request a line of credit to access later. The most important difference between a reverse and forward mortgage: you have no more monthly mortgage payment.
Interest is added to the balance you borrow each month on a reverse mortgage, while the amount of equity you have shrinks.
Reverse mortgages aren’t right for everyone, but there are a number of financial objectives you may be able to accomplish by taking out one.
Pay off your current debt and eliminate your mortgage payment
If you are on a fixed income, reducing your monthly expenses will give you room in your budget to feel more comfortable about spending your money. If you are part of the 48% of Americans over 65 years old with high credit balances, a reverse mortgage may give you additional cash to pay them down, but also address unpaid bills and bring past due obligations current.
Increase your monthly income
If your current fixed income is not enough for you to live on comfortably, a reverse mortgage can supplement your income.
Maintain your independence
As you age, it can become harder to do home maintenance, and if you have any disabilities you may be faced with decisions about assisted living. A reverse mortgage may give you the additional money needed to pay for home-care, or for professionals to help keep your house maintained and safe for you to live in.
Provide you with a cash cushion
If you don’t need cash or income now, you can choose a line of credit option for easy access if you have a sudden decrease in income or unexpected expenses.
However, take caution before signing for a reverse mortgage.
Nearly 10% of reverse mortgage borrowers in the HECM program lost their homes to reverse mortgage foreclosures between 2006 and 2011. As a result, new policies were put into place that require a meeting with an HUD-certified counselor before applying for any reverse mortgage product.
A HUD-approved housing counselor is trained and certified to provide an “impartial education about reverse mortgages.” In plain English, that means no salesperson is involved. The counselor will discuss your financial needs, and provide you with objective feedback about how a reverse mortgage can and can’t meet those needs.
“Consumers need to ensure that a reverse mortgage is a sustainable solution for their financial circumstances,” said Steve Irwin, executive vice president of the National Reverse Mortgage Lenders Association.
Qualifying for a reverse mortgage primarily involves two factors: your age and the amount of equity you have in your home. You can use a reverse mortgage calculator to determine your eligibility. The older you are, the more you are generally allowed to borrow.
The basic requirements to qualify for a reverse mortgage are below:
- At least one borrower must be 62 or older.
- You must own the home you are financing, free and clear of any loans, or have a significant amount of equity. Equity is the difference between how much you owe, and the value of your home.
- The property you are financing must be your primary residence.
- You can’t be delinquent on any federal debt.
- Documentation must be provided showing enough income or assets to cover the payment of your property taxes and homeowners insurance. Since you don’t make a payment on a reverse mortgage, there is no escrow account set up to pay your normal housing-related expenses.
- There is a requirement for you to show creditworthiness.
The approval process for a reverse mortgage is similar to applying for any other type of mortgage. Fill out a loan application, provide documents as requested by your lender, get an appraisal on your home and title work that verifies you have proper ownership, and then you close.
There is one extra step you’ll need to take before you apply for a reverse mortgage: For most reverse mortgages, it’s mandatory to meet with an HUD-approved housing counselor before application and provide proof of that meeting to your lender.
There were some significant changes to reverse mortgages in 2019 that may allow you to access even more equity as homes have risen in value the past five years.
The FHA increased the loan limit on its reverse mortgages from $679,650 to $726,525. This means that people with high-value homes will be able to access more of their equity. “That’s good news for consumers who have homes that have increased in value,” Irwin said.
New proprietary programs
There are also a number of new proprietary reverse mortgage programs being offered in 2019, Irwin said. “That will provide more choices for consumers,” he said. These programs have loan amounts up to $6 million that will provide an opportunity for borrowers to access the equity in properties at high-cost parts of the country.
For customers interested in reverse mortgages who haven’t quite reached the minimum age requirement of 62, a new proprietary product will allow for reverse mortgage financing for borrowers as young as 60 years old.
Another set of programs is geared to the country’s 29 million condo owners. Many of these condominiums are in buildings that not approved by the FHA, so they are unable to pursue the reverse mortgage options offered by the federally-insured reverse mortgage. Proprietary mortgage lenders now offer loan programs that will give condo owners reverse mortgage financing options that are not possible within the limitations of the FHA condo-approval process.
There are three different types of reverse mortgages: single-purpose reverse mortgages, proprietary reverse mortgages and Home Equity Conversion Mortgages (HECMs). Each has specific features that may lower your costs, allow you to take more cash out or let you borrow higher loan amounts.
Features of a HECM
The HECM is the most common type of reverse mortgage. It’s federally insured and backed by the U.S. Department of Housing and Urban Development.
- Qualifying is based on level of need, so borrowers with very difficult financial situations are more likely to be eligible for a HECM than a proprietary reverse mortgage.
- Borrowers must meet an HUD counselor before applying to go over all of the benefits and costs, and discuss other options besides HECM.
- You can receive larger advances at a lower total cost than proprietary reverse mortgages.
- HECMs generally have large upfront costs, financed into the loan.
- You may also be able to live in a nursing home or medical facility for up to 12 months in a row before the loan must be paid.
Features of single-purpose reverse mortgages
These programs are offered by state and local governments as well as nonprofit organizations, but may not be available in all areas.
- Lenders will specify how you can use the reverse mortgage loan proceeds. Some examples may include only allowing use for home repairs, improvements or property taxes.
- Homeowners with low or moderate income are likely to be able to qualify for these programs.
- Fees are usually the lowest of all of the reverse mortgage options.
Features of proprietary reverse mortgages
These are private loans backed by the companies that create them. Approval guidelines vary from lender to lender. While historically there haven’t been many options here, that’s changing, Irwin said.
- May be easier to get approved if you don’t fit into HECM guidelines.
- If you own a high-value home, you may be able to borrow more than the loan amount limits that the government has on its HECM program.
- You may be able to borrow more equity than the HECM limits allow.
- There are no limits on what you can use the funds for.
- Fees are not capped at any specific amount like the HECM program, so they may be higher or lower depending on the lender.
Within the world of reverse mortgages, there are several options for how to actually receive the proceeds of your loan. Here are the main categories.
A single disbursement, or one large sum of cash
If you want to ensure that the interest that accrues on your balance is based on a fixed rate, you’ll want to consider this option. It will net you less cash than other HECM options, but you will have the security of knowing the rate of interest is not increasing on the balance you have outstanding, and still be able to access your equity.
A term option provides fixed income for a specific amount of time
A term option allows you to take some of the money from your reverse mortgage as income for a set period of time. For example, if you are waiting for approval for disability income, or have some unexpected bills you need or want to pay and your current income isn’t enough to cover them, a term option will give you extra monthly income to bridge the gap.
A tenure option provides fixed income for as long as you live in the house
If you’re looking for income for as long as you live in your home, a tenure option taking cash advances at a set amount for as long as you continue to live in your home will give you the security of guaranteed income.
A line of credit gives you flexibility for future needs
If you don’t have an urgent need for additional income, but would feel better having a rainy day financial cushion, a line of credit might be a good option. The credit line only accrues interest on the amount you access when you access it.
A combination of all of the above may be what you need
If you need a combination of some cash upfront, supplemental income and a line of credit to access, a reverse mortgage has the flexibility to provide all of these. Be sure you understand how each component works before you sign your closing papers.
- You loan balance increases while your equity decreases: Because you don’t make payments, your loan balance will increase. The equity in your house is reduced every month you have a reverse mortgage balance outstanding.
- Loss of value to your heirs: If you plan to leave your property to your family, there will be less equity for them as the reverse mortgage balance grows.
- The income you receive could reduce your government benefits: If you receive Medicaid or Supplemental Security Income (SSI), make sure you discuss the effect reverse mortgage income could have on the future receipt of this income.
- The fees are high compared with traditional mortgages: A lender can charge the greater of $2,500 or 2% of the first $200,000 of your home’s value plus 1% over $200,000. The HECM origination fee maximum is $6,000. The upfront fees are negotiable, so shop around to make sure the fees you are being charged are reasonable.
After you close a reverse mortgage, you need to be aware of how the lender will stay in touch with you. There are some important things you’ll need to communicate to your lender if your health or housing needs change.
Here are some things your lender will be checking on.
Your occupancy in the house
Each year your servicer will send you an Annual Occupancy Certification to confirm you live there. If you forget to send it, you may get a visit from an inspector to confirm you are still living there. If they aren’t able to verify that, your lender could consider you in default of your reverse mortgage.
Verification that your property taxes, homeowners insurance and homeowners association dues are paid
Your lender’s servicing company will check to make sure all of these expenses are current, and contact you if they aren’t to discuss ways you can bring them current. They may require that you use some of your reverse mortgage funds to pay any delinquent property expenses.
The death of a reverse mortgage borrower
Your lender must be notified immediately if any person who applied for the reverse mortgage dies. In most cases, a surviving spouse will be allowed to stay in the property, but there may be additional requirements if the surviving spouse was not on the original reverse mortgage.
According to an FBI report, potential losses related to reverse mortgage fraud increased from about $43 million in 2015 to over $97 million in 2017.
Here are a few of the most common reverse mortgage scams and how to avoid them.
You should never borrow money to put into “investment programs.” Although in some cases this may be more unethical than illegal, unscrupulous financial planners may try to persuade you to take the money out to invest in the market. This is not a good use of a reverse mortgage and may be a sign of a mortgage fraud scam.
Home improvement funding
This often involves a knock on the door by someone representing themselves as a friendly neighborhood handyman, with recommendations for work that they can do on the house. Eventually, other experts may begin to recommend costly repairs that may or may not need to be done, and then recommend funding them with a reverse mortgage. If the work has started, and you try to back out, they may attach a mechanic’s lien to your house and try to collect. Only seek out trusted repair services from a licensed contractor.
If a family member suddenly and persistently begins inquiring about your financial condition, and suggests a power of attorney combined with a reverse mortgage, this could be a sign of inheritance fraud.
There are organizations that can help if you believe you are or a family member is a victim of any type of elder abuse. The National Reverse Mortgage Lenders Association produced a brochure with contact numbers for government agencies that will investigate and assist with any signs of reverse mortgage fraud or elder abuse.