With homeowners’ cash needs often outstripping their available financial resources, many people are tapping the equity in their homes. Although home equity loans are a popular choice, some older homeowners have turned to a reverse mortgage to generate cash from their primary home.
The reverse mortgage product has been around since 1961, and continued to be revised through 2017. Before jumping on the reverse mortgage bandwagon, however, take time to understand the upsides and downsides of this income generation method.
How a Reverse Mortgage Works
In a traditional home mortgage transaction, the homeowner is approved for a loan, and makes payments to the mortgage company for a specified period of time. The property serves as security for the debt, and the homeowner retains the home’s title. When the homeowner pays off the loan, the house officially belongs to him (or her).
A typical reverse mortgage loan has some similarities to a traditional mortgage. First, the reverse mortgage loan also uses the home as security, and the title stays in the homeowner’s name. The lender remits the funds to the homeowner in a lump sum or in monthly payments.
Traditional vs Reverse Mortgages
However, there are two big differences between traditional mortgages and reverse mortgages. With a reverse mortgage, the homeowner (the borrower) doesn’t make monthly payments to the mortgage company. Instead, the loan is repaid after the borrower no longer resides in the home, often through the person’s death or move to a long-term care facility.
In addition, a reverse mortgage’s loan balance keeps rising, as the mortgage company tacks on new interest and fees every month. The homeowner must continue to pay their homeowner’s insurance and property taxes. They must keep the home as their principal residence, and the house must remain in good condition.
Several Types of Reverse Mortgages
A Home Equity Conversion Mortgage (or HECM) is the most commonly used reverse mortgage. The Federal Housing Administration (or FHA) provides insurance for HECM mortgages.
Local or state governments, or perhaps non-profits, may also issue special-purpose reverse mortgages. In addition, certain private lenders may extend proprietary reverse mortgages to homeowners in the higher-value segment.
Do Reverse Mortgages Have Funding Restrictions?
The 62+ homeowner may choose to receive the reverse mortgage loan proceeds in a lump sum or in monthly payments. Either way, they’re free to use the money for several purposes.
At one end of the spectrum, homeowners with limited incomes may use the funds for bills, groceries, prescription medicines, or home repairs. More affluent homeowners may choose to travel, buy another property, or simply enjoy extra spending money.
Reverse Mortgage Processing Fees
Homeowners who obtain a reverse mortgage can expect to pay a laundry list of transaction fees. These fees begin with the loan application and conclude when the transaction finally closes.
These fees are similar to those for a traditional mortgage application:
- Appraisal fee
- Credit check fee
- Home inspection fee(s)
- Mortgage fees
- Property survey fee
- Recording fees
- Title search fee
Reverse mortgage applicants must also pay several upfront fees:
- HUD-approved loan counseling fee (required)
- Loan origination fee paid to the lender ($6,000 cap)
- First mortgage insurance premium
Ongoing reverse mortgage loan fees include:
- Annual mortgage insurance premiums (.05% of the loan value)
- Homeowner’s insurance premiums
- Lender service fees
- Loan interest charges
- Maintenance and home repair expenses
- Property taxes
Reverse Mortgage Qualification Process
To qualify for a reverse mortgage, homeowners must comply with some basic criteria. These requirements pertain to the homeowner’s financial situation and the property’s overall condition.
- The homeowner must be at least 62 years of age.
- The homeowner must possess “considerable equity” in their primary home. This number varies according to the lender.
- The homeowner cannot have any federal debt delinquencies (e.g. student loans or federal income taxes).
- The home must be in acceptable condition as defined by the lender’s requirements
- The homeowner must be willing and able to pay for proper home maintenance, homeowner’s insurance, and property taxes
- The homeowner must agree to complete a HUD-approved counseling session. This session pertains to reverse mortgage eligibility and the loan process logistics.
Credit Requirements
Because the homeowner is using their home as the reverse mortgage loan collateral, they may qualify for the loan even with substandard credit. The Federal Housing Administration (or FHA) secures these HECM loans to consumers who probably wouldn’t qualify for another home equity loan.
Home Equity Requirements
The HECM eligibility requirements state that applicants must own the financed property or have paid “a considerable amount” on the loan. Each lender has their own approval criteria that’s based on the applicant’s financial situation and other factors. Examples include the homeowner’s age, the home’s value, the loan type, and current interest rates.
As a guideline, homeowners should have at least 50 percent equity in their homes to qualify for a reverse mortgage, especially with an HECM financing vehicle. This requirement exists because the homeowner must first use the HECM funds to pay off their current home loan.
If the applicant doesn’t own at least 50 percent of the home, the reverse mortgage proceeds won’t be enough to cover the existing loan’s payoff amount. Taking that logic a step further, a homeowner with more equity and a smaller loan balance will have more money available for another purpose.
Can the Homeowner Still Leave the Home to Their Heirs?
The answer is a qualified “yes,” but there’s one very important condition. As long as a reverse mortgage exists, the heirs can’t receive clear title to the property.
To keep the property and receive clear title, the heirs must pay the outstanding loan balance. This usually means they’ll have to sell the home.
Reverse Mortgage Financing Process
Just like buying a home with a traditional mortgage, the reverse mortgage process requires several steps that must be completed in sequence. First, the homeowner should honestly evaluate his or her financial situation and see if it’s possible to raise the funds another way.
If a reverse mortgage seems like the right path, the homeowner fills out the mortgage application. This generally takes about 45 days, depending on the lender.
Next, the homeowner must complete a mandatory financial counseling session with a HUD-approved counseling agency. During this fee-based telephone conversation, the counselor will help to ensure that the homeowner understands the reverse mortgage’s financial implications.
The next step is a formal home appraisal, which determines the amount of money the reverse mortgage will generate. In addition, the appraisal ensures that the home meets the FHA’s standards.
Finally, the homeowner chooses their financing vehicle and decides how they want to receive their reverse mortgage loan proceeds. Once they have completed these steps, they can sign the reverse mortgage loan documents.
Reverse Mortgages: Advantages and Disadvantages
Every financing vehicle has its upsides and downsides, and that also applies to reverse mortgages. Homeowners should carefully consider the following pros and cons in light of their personal and financial situations.
Upsides of a Reverse Mortgage
- Benefits 62+ homeowners with high home equity and limited cash
- Homeowner receives a lump sum or monthly payments in exchange for equity in the home
- Homeowner can use the loan proceeds for numerous purposes
- Homeowners with subpar credit often qualify for a loan
- The loan can include closing costs and additional fees
- Loan proceeds are not regarded as taxable income
- Homeowner can stay in the home as long as they’re able
Downsides of a Reverse Mortgage
- The loan balance constantly increases over time
- The owner’s home equity decreases as the loan balance rises
- Homeowner (or their heirs) must pay back the loan later (often by selling the property or sometimes loosing it through foreclosure)
Because a reverse mortgage can profoundly alter a homeowner’s financial situation, it’s important to have a thorough understanding of the implications of this complex undertaking. Applicants are strongly advised to consult with an attorney, an accountant, and/or a trusted financial advisor before deciding to travel down the reverse mortgage path.
Whether you’re buying, selling, or exploring options like Reverse Mortgages, our murphy nc real estate agents can help you navigate the process with confidence.