Reserve mortgages, which can also be called a home equity conversion mortgage (HECM), work the exact opposite of a traditional home loan. Instead of initiating a loan for a home purchase, those who choose reverse mortgages tap into their existing home equity.
Where a traditional loan requires the homeowner to make payments until the property is paid off, a reverse mortgage gives the homeowner a monthly payment or lump sum in exchange for their home equity. That's why reverse mortgages remain popular with senior citizens; these innovative loans allow individuals and couples to access their home equity without selling or leaving their homes.
How Does a Reverse Mortgage Work?
You may be wondering why anyone would purposely borrow money when their home is already paid off, or they have considerable home equity. The answer is simple; reverse mortgages are mostly utilized by older individuals who want to increase their cash flow without moving. Instead of selling their homes to access their home equity, senior citizens who take out a reverse mortgage can receive monthly income or a lump sum and stay where they are. This is a huge benefit for couples and individuals who need access to cash, but don't necessarily want to leave their homes.
To qualify for a reverse mortgage, borrowers must be ages 62 and older, own a home with significant equity, and live in the home they intend to mortgage.
Borrowers must also participate in a counseling session with HUD to learn more about how reverse mortgages work and their commitment to maintaining their home.
How Do the Payments Work?
Once a homeowner is approved for a reverse mortgage, the bank will make monthly payments to the homeowner throughout his or her lifetime. Monthly payments are based on a percentage of home equity, and the homeowners can use the money however they wish. It's also worth noting that some homeowners choose to take a lump sum instead of monthly payments.
Since the goal of a reverse mortgage is providing income to survivors who still live in the home, it's important to note how reverse mortgages are repaid. Once the remaining survivor who lives in the home passes away or quits using the home as their primary residence, the cash value, interest, and finance charges resulting from the loan must be repaid.
According to the U.S. Department of Housing and Urban Development, however, any remaining equity can be transferred to heirs. Further, no debt associated with the reverse mortgage can be passed onto heirs.
How Much Can You Borrow?
According to the National Reverse Mortgage Lenders Association (NRMLA), a variety of factors can influence the amount of funds a homeowner may be eligible for. Those factors include the age of the home, the value of the home, and the interest rate.
No one gets to borrow the full amount of their home's value. The amount you can borrow is determined using a principal limit factor, or PLF. If your home's value is $200,000 and your PLF is .50, for example, your reserve mortgage may be as high as $100,000. PLF factors are published by HUD, and determined using government data.
How Much Do Reverse Mortgages Cost?
As the NRMLA notes, costs associated with reverse mortgages are typically higher than those on traditional loans. If you choose to move forward with a reverse mortgage, you can expect to pay higher closing costs, origination fees, appraisal fees, and mortgage insurance.
The interest rate on reverse mortgages is typically higher than traditional mortgages as well, which leads to higher ongoing costs over all. Also, keep in mind that even once the reverse mortgage is in place, property owners are still responsible for paying taxes and insurance on their home.
One huge benefit to remember, however, is that the reverse mortgage payments themselves are tax-free. So, despite the upfront costs, homeowners do get the benefit of not having their payments taxed as income.
How Can Homeowners Use the Money?
Homeowners who take out a reverse mortgage can use their monthly payments however they want. They can use their newfound cash to pay bills or pay down debt. Or, they can use the money to have some fun or go on a once in a lifetime trip.
Many reverse mortgage customers want nothing more than some wiggle room in their budgets, so they use their reverse mortgage payments to create more freedom in their lives. Since reverse mortgage customers are older and may not be able to work, many use their reverse mortgage payments to supplement their pension, retirement plans, or social security funds.
Who is a Reverse Mortgage Good For?
The fact that reverse mortgages are only offered to individuals ages 62 and up says it all. By and large, reverse mortgages are for older individuals who have plenty of home equity, but not enough cash. By applying for a reverse mortgage, these individuals can access the equity in their homes and receive monthly cash payments or a lump sum.
What is a Reverse Mortgage through HUD?
While you can take out a reverse mortgage with a private lender, you can also take out a home equity conversation mortgage with the U.S. Department of Housing and Urban Development, also known as HUD. These mortgages are insured by the U.S. Federal Government and are only available through FHA-approved lenders.
Home equity conversion mortgages, or HECMs, work similarly to reverse mortgages. To qualify, you must:
- Be 62 years of age or older
- Own the property outright or have a considerable amount of equity
- Occupy the home as your primary residence
- Not be delinquent on any federal debt
- Have financial resources to continue to pay property taxes, insurance and Homeowner Association fees, etc.
- Participate in a consumer information session given by a HUD- approved HECM counselor
Specific requirements for your property also apply. It must be a single family home or a 2-4 unit property occupied by the homeowner, for example. Your property can also be a HUD-approved condominium unit or a manufactured home that meets FHA requirements.
The amount you can borrow with an HECM depends on:
- The age of the youngest borrower or eligible non-borrowing spouse
- The current interest rate
- Lesser of appraised value or the HECM FHA mortgage limit of $625,500 or the sales price
Finally, the costs associated with an HECM can be significant but are closely tied to those charged with traditional reverse mortgages. Homeowners who choose a government-insured HECM should expect to pay a mortgage insurance premium, closing costs, an origination fee, and a servicing fee that will vary dramatically depending on specific loan details.
If you're a candidate for a reverse mortgage or home equity conversion loan, it's smart to shop around with different lenders for the best loan and rates. Keep in mind that, like with any other loan, interest accrues when you take out a reverse mortgage. By shopping for the best loan possible, you can save money and keep more of your home equity in your own hands.
With the right loan, you'll receive the largest amount in exchange for your reverse mortgage – and with the least amount of expense.
At the end of the day, a reverse mortgage can be incredibly valuable for older individuals who want to maintain their standard of living while accessing one of the biggest assets they have – their home equity. Consider whether or not a reverse mortgage is right for your situation and compare lenders to make sure that you're getting the best terms possible.