Can You Refinance a Reverse Mortgage and Is It a Smart Move?
A reverse mortgage is a type of loan that lets homeowners (62 or older) convert part of their home equity into cash. Typically, reverse mortgages provide homeowners with a regular monthly payment to supplement their retirement income, meet health care costs or make home improvements. Reverse mortgages can be taken in a lump sum or via a line of credit that can be accessed as needed.
The question is, can you refinance a reverse mortgage?
The answer is yes, refinancing a reverse mortgage is possible, though it makes more sense in certain situations than in others. Some homeowners can potentially increase their monthly income with a reverse mortgage refinance. Others may want to refinance a reverse mortgage because it’s the only way to add a spouse’s name.
Is refinancing your reverse mortgage a smart move? That answer comes with a few qualifiers.
When a reverse mortgage refinance doesn’t make sense
Though refinancing a reverse mortgage might be a good choice in certain situations, it is not for everyone. As with refinancing a traditional mortgage, you’ll need to weigh the benefits against the costs.
“In most cases, it does not make sense to refinance a reverse mortgage. It really comes down to looking at the numbers,” says Theo Espinosa, a loan officer and mortgage specialist with The Espinosa Group in San Jose, Calif.
So what are some situations in which a refi is best avoided?
When you have less to gain than you’ll spend on the refi: Whenever you secure a loan, there are closing costs and other potential fees, including mortgage insurance premiums (MIP). You need to pay these every time you refinance a loan, and the sum of the costs can be many thousands of dollars depending on factors like your financial history, your home equity, the appraised value of your home and the loan product you choose.
Before you decide to refinance, calculate how much you stand to gain and consider it in the context of the costs.
The 5-5 rule of reverse mortgage refis
To help you decide if a reverse mortgage refi makes sense for you, the National Reverse Mortgage Lenders Association (NRMLA) has some simple rules:
- The increase in your reverse mortgage loan should be at least five times greater than the fees you’ll spend on things like closing costs.
- The additional money available to the borrower must be at least 5 percent of the amount being refinanced.
You don’t plan to stay in your home long: A reverse mortgage really only makes financial sense if your intention is to continue living in your home for the rest of your life. If you plan to move out to downsize or to enjoy a retirement community, a reverse mortgage refinance is not a good option. Similarly, if you have health issues and foresee a temporary or permanent move to a care facility, refinancing will cost more than the potential gains. Even if the last remaining spouse on the loan is still living, the bank will collect on the reverse mortgage after he or she has moved out of the house for 12 months, even if the move is to a hospital or other necessary care facility.
The value of your home has gone down: Simply put, a decrease in home value is going to result in access to less money.
It hasn’t been 18 months since you took out your reverse mortgage: The NRMLA’s guidelines prohibit refinancing a reverse mortgage for 18 months after it was initiated (or last refinanced). Even if interest rates have dropped or a home’s value has gone up significantly, borrowers are ineligible for a refinancing option until that time has elapsed.
When does it make sense to refinance a reverse mortgage?
Refinancing is not necessarily a good choice for all reverse mortgage holders. “It’s important for people to fully understand the benefits and disadvantages of refinancing,” said Espinosa. The f could make refinancing a reverse mortgage worth considering.
When you need to add a spouse to the loan: A reverse mortgage becomes due when the last person on the loan dies or stops living in the house. If your spouse was not yet 62 when you took out your reverse mortgage, his/her name will not be on the loan. If you obtained a reverse mortgage prior to your current marriage or if your spouse is not listed as a borrower for some other reason, you may need to refinance the loan to ensure that your spouse has a place to live if you should die first. There are some protections for non-borrowing living spouses and other family members living in the home, but often, it’s worth the peace of mind to refinance the loan so their names are included.
Your heirs want to pay off the loan: When all of the borrowers listed on the loan are deceased, it will become the responsibility of their heirs to decide what to do with the home. If your family would like to retain ownership, they must pay back the loan. If your heirs do not have the cash to do this, they may be able to refinance the reverse mortgage as a traditional mortgage and pay back the debt over time. Other options for heirs include selling the property and keeping whatever profit is left over once the lender is paid back, or deeding the property to the bank if the value does not exceed the debt owed on the loan.
You can now borrow more money: As time goes by, many properties increase in value. If your home is worth significantly more now than when you initiated your reverse mortgage, you will have more equity and may be able to draw more money on a monthly basis by refinancing.
So, refinancing when you are older can potentially give you access to more cash if your home value has appreciated and interest rates have stayed fairly constant.
You can get a lower interest rate: Mortgage rates fluctuate with market conditions. If the interest rate has dropped considerably since you took out your reverse mortgage, refinancing might make sense. With less money going toward interest each month, you’ll be able to pocket more.
You’re looking for a fixed interest rate: Most reverse mortgages give the borrower incremental monthly payments. These loans almost always have adjustable interest rates. The uncertainty of variable-rate loans can make some people uncomfortable. That’s where refinancing to a fixed rate reverse mortgage comes in. Additionally, in economic conditions where interest rates are steadily rising, it could be prudent to refinance for a fixed rate.
In most cases, to obtain a fixed-rate reverse mortgage, the borrower needs to take the full loan amount in a lump sum rather than in smaller regular payments. In some instances, this may be beneficial. A financial adviser can help you understand which reverse mortgage interest rate will work best for you.
What you need to qualify for a refi
The Federal Housing Administration (FHA) backs most reverse mortgages, often called home equity conversion mortgages (HECMs). The guidelines for who can qualify for a reverse mortgage refinance loan are strict, but this is for a good reason, says Espinosa.
“There are a lot of predators out there who prey on seniors and have the ability to profit” from reverse mortgage refis,” he says. “That’s why these tests are so strict. They want to prevent people from churning. It has to be a pretty big benefit for the borrower to do a HECM to HECM refinance.”
To qualify for a HECM refi, borrowers must meet the following qualifications.
- The youngest or sole borrower must be 62 or older. Co-borrowers are most often married, but they can be anyone who lives in the house together, including siblings, friends or parent and child.
- Borrowers must be deemed “creditworthy,” as determined by:
- A credit score check
- A review of housing-related payment histories
- An assessment of financial assets and income sources, such as retirement accounts, investments and employment
- An evaluation of household cash flow (for instance, income greater than mandatory expenses)
- A single-family home
- A residential building with up to four units, in which borrower(s) reside
- A Housing and Urban Development-approved condominium unit
- A HUD-approved manufactured home
In addition to these standard HECM qualifiers, the Federal Housing Administration (FHA) requires that borrowers meet the following criteria for HECM to HECM reverse mortgage refinances:
- The additional cash that a borrower will receive from the refi must equal 5 percent or more of the new loan’s proposed principal limit. For example, if the new principal limit is $300,000, the refinance needs to qualify the borrower to receive at least $15,000.
- The money available to the borrower must equal at least five times the refinancing fees, including closing costs. So, if fees are $5,000, the loan refinance must give the buyer access to at least $25,000.
- The reverse mortgage cannot be refinanced for 18 months after the original loan is funded. This is to protect borrowers from loan churning by predatory lenders.
There are other private lenders that offer competing products called “proprietary” or “jumbo” reverse mortgages. These lenders follow their own lending criteria. If your existing reverse mortgage is with a private lender or you intend to refinance your loan with one, ask about their individual requirements.
The application process
The reverse mortgage application process is very similar to the process of obtaining your original reverse mortgage. It starts with reaching out to a lender or mortgage broker to discuss your needs.
“The first step is that we look at what they qualify for. It’s really easy to do. All you need is their date of birth, how much they owe on the property, and how much the property is worth,” Espinosa explains. “From there, we can determine how much the borrower would qualify for, which is called the principal limit. After that, I would prepare a package for them to review.”
Potential borrowers can then review the package with family, financial advisers and estate planners. This is the time to assess whether it makes financial sense to move forward with a refi.
Next, under FHA guidelines, you’ll have to meet with a reverse mortgage counselor. These sessions can be done over the phone or in person.
“The counselor will review the loan with them and how the loan reverses. They want to make sure the borrower is of sound mind,” Espinosa says.
Once the meeting is complete, the broker will begin the approval and underwriting process. If you have participated in a session with a reverse mortgage counselor within the last five years, you can opt out of this part of the process.
Submitting for a reverse mortgage refinance is the same as submitting for any other type of loan. An appraiser will be sent to your home to assess the current value. You will also need to provide a variety of paperwork illustrating your income and assets, including things like recent pay stubs (if applicable), tax returns, current bank statements and statements from retirement accounts. This part of the process can take about 30 to 45 days, according to Espinosa.
Once the loan closes, it goes to escrow and you will need to sign paperwork as with any loan. There is a three-day rescission period. After that, you will be able to access the loan funds immediately and you will begin to receive money in the selected disbursement method.
Hidden costs of a reverse mortgage refi
When taking out or refinancing any loan, there are costs involved. Responsible lenders will make borrowers aware of these costs upfront so there are no surprises as the process progresses.
Closing costs are one of the biggest expenses of engaging in any loan, and a reverse mortgage refinance is no different. Generally, closing costs encompass administrative fees such as document preparation, the running of a credit report, title insurance, and an assortment of courier, escrow and recording fees. Closing costs can be several thousand dollars, depending on the lender and the borrower’s specific situation. Usually, you can choose to pay closing costs upfront or to roll them into the reverse mortgage loan amount, meaning the balance available to you will be reduced slightly by the closing costs.
An initial mortgage insurance premium (MIP) fee is also part of refinancing a reverse mortgage. This fee is intended to protect the lender in case it incurs losses on the loan. Typically, MIP is paid upfront at the close of the refi. It can range from 0.5 to 2.5 percent of the loan amount. Borrowers continue to pay MIP annually for the lifetime of the loan at a rate of about 1.25 percent of the loan balance.
Most lenders charge a loan origination fee as compensation for processing a new loan application. The fee is in proportion with the assessed value of the home. Generally, for the first $200,000 of your home’s value, lenders charge 2 percent or $2,500, whichever is greater. If your home is valued above $200,000, lenders charge 1 percent on the balance with a maximum cap of $6,000.
Interest is something most borrowers expect to pay when taking out a loan. With a traditional mortgage, borrowers pay interest and a portion of the principal each month until the loan is paid off. With a reverse mortgage, the borrower receives a portion of the principal each month. When the last remaining borrower passes away or permanently moves from the home, heirs must pay the principal and interest back in order to retain ownership of the house. The interest rate is determined by market index, the specific loan product selected, and the lender’s margin.
Reverse mortgage holders are also responsible for continuing to pay general homeowner expenses: property tax, insurance, homeowner’s association fees (if applicable) and regular home maintenance costs.
8 Questions to ask before you apply for a reverse mortgage refinance
Before making the decision to refinance your reverse mortgage, it may help to ask yourself the following questions:
- Am I planning to continue to live in my home for the remainder of my life? Do I have the resources to do that even if my health begins to fail?
- Can I afford to continue maintaining my home and handling general upkeep for the rest of my life?
- Have I spoken to my family about my reverse mortgage so that we are all on the same page regarding my finances and plans for the future?
- Are there others who live in my home who need some kind of protection that will allow them to stay in the home in the event of my death?
- Has my home value appreciated significantly since taking out my reverse mortgage?
- Have the interest rates decreased significantly since taking out my reverse mortgage?
- Will the amount of money I stand to gain from refinancing more than cover the fees and closing costs I will incur from doing so?
- Does my lender operate by FHA standards? Does the company have a good track record and positive feedback from borrowers? Is it possible that the lender is trying to take advantage of me in some way?
If your family is on board, you stand to gain money and your lender is trustworthy, refinancing your reverse mortgage could be a smart choice for you.