Reverse mortgages are not inexpensive to set up, and processing them can take some time. (In most cases you have to attend reverse mortgage counseling before you're allowed to apply.) Many people believe that if they're going to jump through a bunch of hoops and pay substantial fees, they want to borrow as much as they possibly can.
The amount you can borrow using a reverse loan is largely determined by three factors:
- Your age: The younger you (and your spouse, if applicable) are, the longer the term of the loan is likely to be, and the smaller the amount you can borrow. Keep in mind that you have to be at least 62 years old to apply for a reverse mortgage.
- The amount of equity in your home: You can only borrow a proportion of your principal residence's appraised value, and any existing mortgage or other borrowing secured by the property must be eliminated by the proceeds of the reverse mortgage.
- The interest rate you're charged: The higher the rate, the less you're going to be able to borrow. Of course, interest payments along with most other charges are added to the loan balance and only fall due when the borrower moves or dies.
To get a feel for your personal borrowing potential using one of these products, you need first to recognize that these loans come in one of two flavors. And each is very different from the other.
Jumbo or Proprietary Reverse Mortgages
The first, "jumbo" or "proprietary" reverse mortgages, are not guaranteed by the Federal Housing Administration (FHA). They're entirely private deals between individual lenders and consumers and are subject to fewer regulations. That means the only caps on borrowing, and the only rules about how much you can take, are those imposed by the lender. If your home has a high enough value, you can borrow literally millions of dollars. For some wealthy people who need a cash injection, a jumbo product can be a smart move, because withdrawals from these are not -- unlike many other assets that could be realized -- currently subject to capital-gains tax.
However, that light-touch regulation comes at a price, and some proprietary products come with high costs and potential risks, so it's important to shop around extensively and to take independent professional advice before making a commitment.
Home Equity Conversion Mortgages
The second flavor is the home equity conversion mortgage (HECM, pronounced "heck 'em"). These are guaranteed by the FHA, and thus are more heavily regulated. This has some upsides: borrowers have to undergo one-on-one independent counseling before signing up, and costs are capped. But it also brings some strict rules concerning how much may be borrowed and when cash may be withdrawn. These include:
- Loan-to-value (LTV) ratios are based on the home's appraised value or $625,000, whichever is lower.
- The proportion of your home's value that can be mortgaged (LTV) is calculated based on your age and current interest rates. Typically, the range is 50 percent to 80 percent of the maximum. Older borrowers get a higher percentage than younger borrowers.
- You may withdraw only 60 percent of your total loan as a lump sum during the first year of your HECM*. If you opt for an adjustable-rate line of credit or a monthly payout, you can access your remaining loan balance after the first year.
- If you choose to finance your closing costs through the HECM (rather than pay them upfront), they will be deducted from your loan balance.
- If you have a younger spouse, even if he or she is not on title to the property and not obligated by the HECM, his or her age will be considered when calculating your maximum loan amount. That's because if the older spouse dies, the younger one is allowed to continue living in the home.
- HECM borrowers are subject to a Financial Assessment to make sure they are capable of managing their housing-related obligations like insurance and property taxes. If the applicant does not pass the assessment, the lender can withhold some of the loan proceeds and use them to pay these costs ion the borrower's behalf.
* There's an exception to the first-year borrowing cap: If you have an existing mortgage secured on your home with a balance greater than 60 percent of your new loan, you must immediately pay that down in full from your reverse mortgage's proceeds, and you may still additionally take during that first year a lump sum of up to ten percent of the total loan amount.
When considering how much to borrow with a reverse mortgage, it's important to remember the ongoing costs of home ownership: property taxes, hazard insurance premiums and maintenance all remain your responsibility, and a failure to keep up with them can lead to foreclosure. That's why it can be smart to take a significant proportion of your borrowing in the form of monthly payments or a line of credit.
For more information on these and other issues, check out "Reverse Mortgage Advantages and Disadvantages."